When Do I Need Life Insurance?
Fee-for-service financial planner and founder of PlanEasy.ca
Insurance helps you manage risk. Specifically, financial risk.
Insurance is great for highly unlikely but catastrophic risks. Things like a car accident, large medical expense, house fire, or an unexpected death.
Each of these risks could have massive financial consequences if they were to happen.
Luckily, the chances of these happening are extremely slim, however, there is always still a chance. Buying insurance helps you mitigate that very small chance by insuring against it. If you do experience some bad luck, your insurance will help cover the financial impact.
Before we jump into when you might consider life insurance let’s first cover what insurance is in general.
What is insurance?
Insurance helps spread out financial risk. An insurance company will sell 1,000’s of insurance policies for a specific risk (like a house fire) but only pay out a few times per year. They take a small premium from 1,000’s and maybe pay out a large amount to a few unlucky people (plus they make a bunch of profit too!)
Insurance companies help spread out this risk by selling hundreds of thousands of insurance policies each year.
Why buy insurance?
The best time to buy insurance is when you could potentially face catastrophic financial risk. Financial risks that would be unbearable if they were to happen to you. Risk that could lead to a big lifestyle downgrade, or that could leave you without income, or that could lead to bankruptcy.
Insurance isn’t the only solution. The alternative to insurance is to “self-insure.” In some cases, it may make sense to self-insure rather than buy expensive insurance.
For example, if you had a ‘beater’ car worth $2,000 you may not purchase collision insurance. Instead you self-insure. If you get into an accident you need to cover the cost of the repair or buy a new car. But given the risk is $2,000 you might be willing to take that risk yourself rather than buy expensive collision insurance.
Buying insurance is good when the risks are too large to bear yourself. How much risk you can bear yourself will depend on your personal situation.
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When do I need life insurance?
Generally, you need life insurance when you have people who are dependent on your income. People who would face unbearable financial consequences if you were not around.
Dependents are usually young children who rely on you to earn an income and provide a certain standard of living.
You may also consider a spouse to be a dependent if they rely on your income.
You may also have other dependents that you provide for, like aging parents, or a family member with a disability.
If you have someone dependent on your income, then you may need to consider buying life insurance. Once you decide that you do need life insurance, then the question becomes “how much life insurance do I need?” That’s a question we’ll tackle in the next post.
“The best time to buy insurance is when you could potentially face catastrophic financial risk”
When DON’T I need life insurance?
Do you always need life insurance when you have children or a spouse? Not necessarily.
If your family won’t face unbearable financial consequences, then you may not need life insurance at all. The key is to decide what is “unbearable” given your unique financial situation.
Personally, we’ve chosen NOT to purchase life insurance even though we have two young children. Why? Well, we wouldn’t face unbearable financial consequences. If one of us were to pass away, it would be difficult, there is no doubt about that, but not financially unbearable. If one of us were to pass away, tough decisions would need to be made, but we have options.
In our case, we’re lucky that both of us can earn a decent income. We’re also lucky that we’ve been able to pay off our mortgage early. We also keep our expenses reasonably low. We wouldn’t face unbearable financial consequences if one of us were to pass away, so we’ve decided to forgo life insurance.
If something extremely tragic were to happen, and both my wife and I were to pass away, the equity in our home, in addition to our savings, would be sufficient to provide for our children until they’re adults.
Thinking about life insurance is emotional
Thinking about life insurance can be difficult. It’s an emotional topic and difficult to consider rationally. Having a trusted financial planner or life insurance agent can help ensure you make a rational decision.
If you need help deciding on life insurance, or if you want a full review of your financial situation, consider starting a financial plan with us. We can help you walk through the life insurance decision and see how it fits within your overall financial plan.
Financial planner, personal finance geek and founder of PlanEasy.