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February 1, 2021How Much Life Insurance Does a Business Owner Need?
If you have followed me for a little while, then you know that I am a big proponent of insurance. Life comes at us fast and we just never know when disaster may strike. Therefore, it’s just good practice to protect ourselves as much as possible. In today’s post, I want to talk about life insurance. Providing a source of income for your loved ones after you’re gone is one of the most loving things anyone can do. But how much life insurance do we need? It might not be what you think.
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TIME INDEX:
- 00:45 – How Much Life Insurance Does a Business Owner Need
- 03:09 – Personal Factors
- 06:38 – Factoring in Debt
- 07:59 – What Matters
- 10:43 – A Common Mistake
- 13:37 – Summary
Life Insurance – How Much Do Business Owners Need?
I’ve often heard the talking heads spout off this magic number when discussing how much life insurance we need. For years, it’s been said that we need 10 – 15 times our income in order to provide for our loved ones after we’ve passed. But is this the case when it comes to business owners?
According to the 4% rule, we can withdraw 4% of our portfolios each year, in retirement, for a comfortable life. Based on this, we can calculate what we need to have in savings and investment assets to bridge the retirement wealth gap. To keep things simple, let’s assume that you’re earning $100,000 per year. In order to replace your annual income using the 4% rule, you would need $2.5MM in retirement assets. But it’s not that simple, folks.
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In order to understand how much life insurance we will need, we must first understand how much we need in general. So, using a rough calculation, we can figure out how much life insurance we will need to keep up with our personal financial lifestyle. For this calculation, I’m assuming that we will need around $15,000 for burial expenses and that we are only covering 10 years’ worth of income (this is just long enough to see my youngest son come of age). And finally, we’ll assume that we have $100K in investment accounts.
By My Calculations…
According to the assumptions, we need just under $1MM in life insurance. So, that’s really close to the low end of the suggested 10 – 15 years of income that the experts suggest for life insurance. But here’s where it gets a little tricky. I don’t want my wife to suddenly have to look for active employment. She has spent the past 16 years raising and homeschooling our children and I want her to be able to continue living the life that she’s grown accustomed to.
With that in mind, I need to adjust my calculation. So, I’m still going to assume that I need $15,000 for burial expenses. I’m still going to have the same $100K in my investment accounts. However, I’m now going to need to provide an income for the next 40 years. Likewise, I’m going to cover the full expense of each of our children’s college education, valuing that at around $120K each.
Suddenly, I need a lot more life insurance. By my calculations, I will need $2,535,214.98 to provide the life I want to leave my family with. That’s well beyond the expert’s suggestion.
Debt Matters
So, now we have looked at the bare minimum and the maximum provisions for our families. These are a good starting point when considering just our personal finances. However, most people have debts that will need to be paid upon their passing. In fact, many insurance experts advise that you have enough insurance to ensure that your spouse or significant other is left with no remaining debt.
Once again, we can use the same assumptions to find our next level of life insurance needs. We’re still assuming the need for $15,000 in burial expenses. Likewise, we will still have $100K in our investment accounts, $120K for each child’s education, and a 40-year timeline for income replacement. But this time, we will include a one-time expense of $400K to pay off our remaining debts within a 1-year window.
As you can see, we now need $2,920,214.98 in life insurance. So, we went from just under $1MM to nearly $3MM in recommended coverages. Which one is right? Well, that depends on your unique situation. The bottom line for most business owners is that we have to remember to take care of the home—not our businesses—first. Once we’ve ensured that our loved ones will be taken care of, then the rest of our life insurance decision is an academic one.
Business Owner’s Needs
With these basic calculations, it’s clear that using the generic “ten to fifteen year” rule, we could come up well short of what we actually need. As business owners, we run the danger of falling prey to the idea of taking care of the business to the detriment of their families. You see, many times, we are required by institutions or contracts to carry additional life insurance.
Let’s assume that you need some new equipment and your bank requires you to secure the loan by allowing them to take a collateral assignment out of your life insurance. If you haven’t set your insurance up properly, the bank will get the money that was intended to go to your family. Thus, leaving them reliant on the sale of your business to survive. The same can happen with buy/sell agreements, debt reduction, etc.
In Conclusion
Life insurance is a relatively inexpensive way of protecting your loved ones if anything ever happens to you. However, having too much or too little insurance can be a very harmful thing. Too much and you’re paying far more than you should. Too little and your family isn’t likely to receive the benefit that you set aside for them. So, take care of home first. Find out what you need to provide for your family and go from there.
If you aren’t sure of exactly how much insurance you need or if you just don’t want to hassle with it, reach out to us. We have experts at our disposal that can help you with this. Friends, life is tough but it’s so good. Life insurance can be frustrating but it doesn’t have to be. With the right plan, caring for our loved ones after we’ve gone can, at least, be financially simple.
Need help finding the right amount of insurance for you? Reach out to us! The Financially Simple team has helped thousands just like you.