What Type of Life Insurance Do You Need? And How Much?

5 minute read

When you are looking at the different types of life insurance something that seems very simple actually becomes a more complex.
All of the insurance jargon can leave you feeling confused and overwhelmed.
However, when broken down, life insurance is actually fairly simple.

What you'll find is that it’s in deciding which type of life insurance to get where many doctors make mistakes that end up costing them money, so I’m going to go in-depth into the different kinds of life insurance.

The first type is term life insurance, and this is what most people buy—especially non-physicians.

Term life insurance is basically the lowest price type of coverage that you can get and it covers you for a specific period of time.

For example, let’s say that you want to get a million dollars of coverage for the next 20 years, so you might get a 20-year term policy.

What that means is for 20 years you’re essentially going to rent your insurance. You’re going to pay a certain level premium and during that time it’s fairly inexpensive.

Then at the end of the 20 years the policy expires and you don’t really have anything to show for it.

It’s kind of like renting an apartment in that you don’t build any equity in the policy, but it’s a very inexpensive way to protect yourself over a period of time.

It’s a good choice if you need life insurance for a specific period of time, like if you have children that are going to be in the house for the next 15 years.

If you want the most affordable coverage and you know there is a time limit for when you need the most coverage, term life insurance is flat out the least expensive and will free up the most liquidity for you to do other things.

So keep in mind, term life insurance is inexpensive and good if you want it for a specified period of time, and know that it will expire in the future and could leave you with fewer options as you’ll be older and your health might change between now and then.

So if you want to extend your coverage you may be left with either some bad or really no options, so you really want to take that into consideration.

A permanent cash value policy, on the other hand, never expires.

Like owning a home, it does build equity over time. If you buy a permanent cash value policy then you’re going to actually own something that can be withdrawn tax-free in retirement.

It is going to be much more expensive than the term insurance; however, you get to keep some of it so you just have to look at the trade-offs.

The majority of people should not be permanent cash value life insurance; high-income earners like executives and physicians are the ones who are most likely to get this kind of life insurance.

There are four different kinds of permanent cash value life insurance: whole life, universal life, variable life, and index universal life.

With whole life insurance there’s a guaranteed benefit, and they’ll even give you a guaranteed earnings rate.

If you buy a million dollar whole life policy and there is a 3 percent guaranteed rate of returns means that you will never have a lower return than that, you will pay a level premium, and you can earn dividends above that minimum.

This is the oldest and most basic permanent life insurance type. In the 1970's when interest rates were in the double digits and you could have got 15 percent dividends from a whole life policy they were great; now, however, you’re looking at much lower returns and with the internal cost of the policy that means your net return is much lower.

Because of that it’s not always the best investment of your money, so we tell most young doctors that whole life insurance can be helpful but only if you’re in a position where you feel comfortable with the money going into it earning returns similar to bond returns.

It is going to be safe and it is guaranteed for your entire life, but you still need to take into account that the cash value is an investment for you and it might not be the most efficient or effective way to grow your wealth if you’re younger.

That’s where some of the other policies come into play.

Universal life is a bit more flexible than whole life.

Whole life is much more rigid, you could miss one payment and likely lapse the policy. Universal life is set up so that if you miss a payment the cash value kicks in and pays it for you so you can make up payments or miss payments and it will keep going.

The premiums can change, they’re not level so they can go up or down. It is typically a bit cheaper than whole life, and again the returns resemble bond returns.

Most people who are in their thirties or even forties are probably looking for a higher return than that, but universal life is a good step from whole life because it gives more flexibility and slightly lower prices.

Variable life allows you to take those premiums that you’re putting into your policy and allows you to invest it.

There can’t be actual mutual funds in it because it’s an insurance product, but they have what are known as sub-accounts that are set up to mirror mutual funds.

Now you can take advantage of higher long-term growth and being able to invest that money while still having permanent life insurance.

You can take advantage of having that money in an account that can be withdrawn tax-free to use for education funding or retirement but that doesn’t have the same penalties that a 401(k) plan would have.

It is also beneficial because it has some additional protections. It’s hard for people to get at money inside of a cash value policy so it’s got some protections against lawsuits.

The death benefit value can increase or decrease depending on how much money you’ve put into it. It is riskier but it has the potential for higher returns.

Another downside is that your monthly or annual insurance costs are determined by the amount of death benefit you have over the amount of cash value you have.

Let’s say you start off with a million-dollar policy and after a few years you have four hundred thousand dollars of cash value in the policy. Now you will only be paying the insurance cost on six hundred thousand dollars of insurance.

But what happens if the market goes down? That’s a big thing that ruined a lot of variable life contracts all of a sudden in the early 2000s.

If the market goes down and half of your cash value is lost, now you’re back to paying insurance cost on eight hundred thousand dollars of insurance.

The last form of insurance, indexed universal life, helped to solve that problem.

Indexed universal life allows you to invest your cash value into market indices.

And so you would be able to invest in the S&P 500 or other market barometers so you’re getting market returns but with a hedging strategy that makes it where you can’t lose investment money if the market goes down.

For example, if you have a variable life insurance policy and the market goes up by 20 percent you get that 20 percent but if the market goes down by 20 percent you lose it.

With indexed universal life, if the market goes up by 20 percent you might only get 12 percent, but if the market goes down 20 percent you won’t lose anything as far as investment value.

This is a way to get permanent life insurance that lasts for your entire lifetime that will eventually pay out your beneficiaries, that will build cash value you can use for retirement or anything else along the way tax-free, that also has some protection against market losses.

This can be a good way of diversifying where you have some insulation against market losses as well as tax-free retirement income and lawsuit protection.

Most physicians are going to buy either all term life insurance or some blend of term life with some other cash value product.

Just know that not all cash value policies are the same, and typically if someone is interested in cash value life insurance we lean toward indexed universal life.

But be sure you evaluate all of your options and keep all these things in mind to determine whether term or permanent is best for you and, if permanent life insurance is a part of your plan, that you’re getting the right permanent cash value policy.

One of those prevalent questions that we get asked by physicians is "How much coverage do I actually need?"

And it is true that there are people out there who will sell you too little, and people who will sell you too much, and it’s not good to be in either situation.

When it comes to determining your needs there are multiple methods.

Some people like to take a more general approach, some people like to project things into the future, some like to add up specific costs in their lives and determine their need that way.

When you’re thinking about how much coverage to get, there are a few things to consider.

One is how much will be needed to meet immediate obligations. If you were to pass away, do you have debt that needs to be taken care of? What do monthly expenses look like? Are there burial costs?

Think about the immediate needs and obligations that your loved ones that you leave behind may have to meet.

Also consider how much future income is needed to sustain the household. How long will children be in the house, and what do their costs look like?

So you need to consider how much is needed to sustain that household as if your income were still coming in and how much future income is needed to fund education and retirement for your spouse.

Probably the easiest rule of thumb a lot of physicians use is the ten times rule, where they buy ten times their base salary or income because that will provide their family with about ten years’ worth of income.

And in most cases, if your family has ten years’ worth of your income that’s going to get children closer to or out of the house and will allow for the adjustment to take place more slowly over time.

It’s a tried-and-true way of calculating basic coverage needs so it’s not a bad way to do it. It’s simple and can provide that peace of mind.

Some physicians will buy ten times their income plus an extra hundred thousand dollars for each kid’s education, so it’s a bit of an enhancement to the ten times coverage calculation.

Finally, you have the DIME method, which is Debt Income Mortgage and Education. Just know that if you’re doing it this way, it will take a bit more calculating.

The DIME method has you taking your debt, your income, your mortgage, your children’s educational costs, and adding it up to get a specific amount for your family and situation.

So whether you use a very specific method like the DIME rule or the ten times process, I think as long as you’re thoughtful in the process and you get the right amount of coverage that you determine or that someone helps you determine, that it really will give you that peace of mind that you got the right coverage and right amount of coverage to protect your loved ones.