Life insurance

Life insurance might be better thought of as “death insurance” because it relates to dying prematurely.

When thinking about life insurance, think about what would happen if you were to die. If you have any dependents, how much would you want to leave in order to support them? For example, would you want to leave money to provide for accommodation, education for your children, and support for your partner so they can continue to work or get back into the workforce? Do you need to provide for funeral and administrative costs?

Some of these things may be covered by the assets you currently own. Ideally, you should aim to be able to “self-insure” in relation to premature death before you retire. Another factor is the age and situation relating to your dependents. As your children get older and become financially independent, this should reduce the amount you need to leave.

Case study - Jack and Jill

Let's consider Jack and Jill's life insurance needs as they go through their adult life.

As a young, married couple, with an infant and a toddler, it's likely that their life insurance needs are highest. They've built up a small amount of wealth (they've saved $100,000 for a house deposit and have approximately $40,000 in KiwiSaver between them). If one of them passes away, they want to ensure the survivor has the funds to buy a home valued at approximately $600,000, pay for the funeral and administrative costs such as probate ($20,000 or thereabouts), and provide a buffer of $100,000 so the survivor doesn't have any immediate pressure to work as they adjust to their new situation in life. They want to leave a lump sum that is earmarked for their children's education ($50,000 per child, or $100,000). Plus, they want to leave a lump sum payment that provides for additional income to the survivor for 17 years (ie, until their youngest child turns 18). Because Jack earns more than Jill, he wants to leave Jill with an income of $50,000 per year. Jill will instead leave a lump sum to provide Jack with $20,000 per year. Assuming the lump sum generates a constant, inflation-adjusted, after-tax return of 4% per year, this means Jack's lump sum will be approximately $610,000 and Jill's lump sum will be approximately $250,000. After calculating what they want to leave the other ($1.43 million for Jack and $1.07 million for Jill), they consider their current asset situation ($140,000), and subtract this figure. They decide on $1.3 million cover for Jack and $930,000 cover for Jill.

Twelve years on, Jack and Jill have two teenagers. They've been living in the house they own for several years now, and have been building up wealth in the form of equity in the house (they owe $250,000 on the mortgage) and KiwiSaver funds (up to $250,000). If one of them passes away, they want the mortgage repaid; provide for $20,000 to cover funeral and administrative costs; provide a $100,000 buffer to the survivor; earmark $100,000 for the kids' education; and provide a lump sum giving the survivor $30,000 per year for the next 5 years (until their youngest turns 18). (The figure is the same for both of them because they earn the same amount and they feel less uncertainty about what their future expenses will be. Based on the same assumptions, this comes to about $135,000.) Based on this information, the amount they want for the other to be $605,000. If they subtract their combined KiwiSaver balance of $250,000, this falls to $355,000. In short, their insurance needs have fallen substantially since when their children were younger.

Soon after the children leave home, Jack and Jill might find that they don't have a need for life insurance any more. It may be a bit moribund to say, but as they repay their mortgage and build up a nest egg for their retirement, the financial downside associated with one of them dying becomes less and less - and in fact, at one point, one of them dying results in the other being better off financially (if not emotionally) because it means their retirement savings would only need to cover the expenses of one person rather than two.

A final comment: mortgages are red herrings

Many people - including many insurance advisers - seem to focus on mortgages when it comes to what is a suitable level of life insurance cover. However, the more important thing to focus on is how you want to provide for your loved ones if you pass away. I won't go into this in detail in this course, but I encourage you to read my article explaining why "Mortgages are red herrings when it comes to life insurance cover".