The Most Important Financial Decision You're Probably Ignoring

The average life expectancy for someone born after 1970 is more than 70 years, and if you make it to 65, odds are good you'll make it past 80. It's amazing, and many of us have taken steps to invest and save so that when we reach old age, we'll be able to enjoy the quality of life that we want.

But as much time and effort as we put into investment planning, we often overlook the most valuable asset that we possess: our ability to generate income, especially during prime earning years. Simply put, the odds are that you probably don't have enough life insurance -- if you have any at all. I spoke with Accuquote founder Byron Udell about the state of life insurance in the U.S., and he gave some great insight into some important reasons why people need life insurance. 

As Mr. Udell put it to me, while life insurance can't replace a spouse, it can replace his or her economic value. Is your family prepared to replace that lost income? 

A grim but important topic
Here are some mortality statistics from the Centers for Disease Control and Prevention:

Source: CDC.

As you can see, death rates are low for people in those prime earning years of between 35 and 64 years of age. Because of this, as well as the uncomfortable nature of facing our own mortality, it's easy to ignore the potential implications for our loved ones. Often, the only life insurance people carry is what their employer offers at little or no cost. It doesn't require a medical exam or a meeting with an insurance rep. And because any cost can usually be deducted from payroll, it's easy just to sign up and forget about it. 

Accuquote's Byron Udell is passionate about life insurance. Source: Byron Udell.

The problem? A typical life insurance plan through an employer only covers about one year's salary. Even for those who buy policies on their own, the average coverage amount for all individual policy holders is $167,000, according to LIMRA. While that may sound like a lot of money, think about it this way: The average household income is around $50,000 annually, meaning a $167,000 insurance policy is about three years' worth of income and the funeral expenses. If the primary breadwinner dies at 45 years of age, $167,000 would leave survivors $833,000 short for the next two decades. Udell had this to say:

I don't understand why this is so tragically overlooked by financial advisors. Everybody that advises people on money always tells them the same thing: 'You've got to diversify. You've gotta have some stocks, and some bonds, and some real estate, and cash for a rainy day.' But they don't talk about life insurance as an asset class that mitigates a very real risk that diversification is supposed to protect you against. But it doesn't protect you against not having enough time to complete the plan. If you die when you're 34 or 44, you didn't get it done, and you still have three kids and a spouse left behind.

Keeping it simple 
There are a lot of life insurance options out there, and it's probably worth talking to at least one professional, if not several. And while I'm not an insurance pro, I think that -- as with investing -- keeping things simple is probably the best approach for most folks. Here are a few tips:

  • Start by considering the amount of earnings that would be lost between now and your retirement. That's how much coverage you probably need.
  • Life insurance doesn't have to be an investment vehicle. Do you expect a return on your car insurance?
  • Term life is fine: Remember, you're just making sure your ability to earn income is replaced in the event of your death.
  • Make it part of your annual financial review to shop around for better rates than the term policy you have now.

Don't mistake low probability for no probability 
Chances are you probably won't die young, but if you do, the financial loss could be just as bad as the emotional loss. And while you can't be replaced, those years of lost income can be offset. Take the time to research the options available to you. It may not be a comfortable topic, but a little discomfort is worth it to make sure that your loved ones will not face financial devastation on top of the emotional devastation of losing you.

More great advice about financial planning
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