Life insurance is a topic that many people avoid thinking about, but it can be a crucial part of your financial plan, especially if you are pursuing financial independence and early retirement (FIRE). In this blog post, I will explain the basics of life insurance, who needs it, how much to get, and how to save money by laddering policies.

What is Life Insurance and Why Do You Need It?

Life insurance is a contract between you and an insurance company, where the company agrees to pay a lump sum of money to your beneficiaries if you die during the term of the policy. The purpose of life insurance is to protect your loved ones from the financial impact of losing your income and support.

You need life insurance if you have people who depend on you financially, such as a spouse, children, or aging parents. If you die unexpectedly, life insurance can help them cover expenses, pay off debts, fund education, and maintain their lifestyle.

However, you don’t need life insurance if you are single with no dependents, or if you are financially independent, meaning you have enough assets to support yourself and your family indefinitely without working. In these cases, life insurance is redundant and unnecessary.

What Type of Life Insurance Should You Get?

There are two main types of life insurance: term and cash value. Term life insurance is the simplest and cheapest option. It provides coverage for a fixed period of time, usually 10 to 30 years, and pays a death benefit only if you die within that term. Term life insurance is ideal for most people who need life insurance, as it allows you to match the duration and amount of coverage to your specific needs.

Cash value life insurance, on the other hand, is more complex and expensive. It combines a death benefit with a savings component, where part of your premium goes into an account that grows over time. Cash value life insurance can be whole, universal, or variable, depending on how the savings component is invested and managed. Cash value life insurance is rarely a good option for most people, as it has high fees, low returns, and tax implications. There are only a few situations where cash value life insurance might make sense, such as estate planning, charitable giving, or asset protection.

How Much Life Insurance Do You Need?

The amount of life insurance you need depends on your financial situation and goals. A common rule of thumb is to multiply your annual income by 10 to 15 times, but this may not be accurate for everyone. A better way to calculate your life insurance needs is to use the net present value (NPV) framework, which considers your current and future expenses, income, and assets.

The NPV framework is based on the idea that the lump sum of life insurance should be equal to the amount of money you need to achieve financial independence, minus the amount of money you already have saved for retirement. In other words, life insurance needs = FI number – retirement assets.

To use the NPV framework, you need to estimate your FI number, which is the amount of money you need to support your desired lifestyle indefinitely without working. A common way to estimate your FI number is to multiply your annual spending by 25 to 30 times, based on the 4% rule of thumb. You also need to estimate your retirement assets, which are the amount of money you have invested in accounts such as 401(k), IRA, brokerage, etc.

For example, if your annual spending is $50,000 and you have $500,000 in retirement assets, your FI number is $50,000 x 25 = $1.25 million, and your life insurance needs are $1.25 million – $500,000 = $750,000.

As your retirement assets grow and your FI number decreases, you need less life insurance. Therefore, you can save money by laddering policies, which means having multiple policies of different term lengths and amounts, and dropping some of them as you get closer to FI.

How to Ladder Life Insurance Policies?

Laddering life insurance policies is a strategy that allows you to adjust your coverage and premiums over time, based on your changing needs. Laddering involves buying two or more term life insurance policies with different durations and amounts, and letting some of them expire as you accumulate more wealth and need less protection.

For example, if you need $750,000 of coverage for 20 years, you can buy a 20-year policy with $500,000 of coverage and a 10-year policy with $250,000 of coverage. If you die in the first 10 years, your beneficiaries get $750,000. If you die in the next 10 years, they get $500,000. If you survive the 20 years, you have no coverage, but you should have reached FI by then.

Laddering policies can help you save money on premiums, as shorter-term policies are cheaper than longer-term policies. It also gives you flexibility to cancel or keep some policies, depending on your progress towards FI.

To ladder policies, you need to compare the rates and benefits of different term lengths and amounts, and find the combination that suits your needs and budget. You can use online tools such as PolicyGenius to get quotes and compare policies from various insurers.

Conclusion

Life insurance is an important part of your financial plan, especially if you have dependents and are pursuing FIRE. You should get term life insurance, not cash value life insurance, and use the NPV framework to determine how much coverage you need. You should also ladder policies to save money and adjust your coverage over time. By doing so, you can protect your family from financial hardship and achieve your FIRE goals.