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Life insurance and FIRE
Figuring out how much life insurance you need doesn’t have to be difficult. (If you’re having trouble getting started, there’s a plethora of articles and calculators to help.)
However, in the FIRE community, we do things a little differently, so mainstream financial advice often doesn’t work for us. That’s why I wrote this post—to share a FIRE-focused method to help you calculate your life insurance needs.
Where FIRE diverges
Like mainstream retirement advice, mainstream life insurance advice tends to be focused on multiples of your income. This calculation may be simple but it’s faulty.
FIRE seekers know that basing such calculations on income is inaccurate for two reasons:
- Income has little correlation to how much money we actually need to live on.
- Looking only at income doesn’t consider whether we spend or save most of it.
Therefore, if you’re spendy, X times your income could leave your loved ones vastly underinsured. But if you’re a saver, you could be paying for more coverage than you need.
Neither of these outcomes is desired nor ideal. It’s far better to base your life insurance coverage on your spending and needs—NOT your income.
This leads to a far more accurate calculation for FIRE and for how much life insurance we need. In turn, we end up paying for the right amount of coverage and are neither over nor underinsured. 👍
How much life insurance do I need (as a FIRE seeker)?
As mentioned, calculating how much life insurance you need isn’t difficult. I’ll take you step-by-step through the process my husband and I used to figure out how much we needed.
Here’s a summary of the steps:
- Discuss desired lifestyle.
- Calculate FI number.
- Add up debts.
- Add the extras.
- Add up assets and income.
- Make the final calculation.
Below, I’ll break down each step in detail and point out areas where FIRE considerations come into play.
Step 1: Discuss your desired lifestyle
Before you can work on the numbers, you first need to think about the type of lifestyle your beneficiaries will have after you’re gone. Getting clear on this will make the rest of the life insurance planning process that much easier.
Below are some questions you’ll want to consider:
- If you have a partner, will they continue to work after your death?
- If so, will it be full time or part time? Also, when would they like to retire?
- If you have kids, who will care for them? Will it be their surviving parent, other family, or paid caregivers?
- If you have a partner, will they keep working even if they’ve reached FI?
- If you have a partner and/or kids, will they maintain the same lifestyle or will they downsize, move, or inflate their lifestyle?
- Do you want the death benefit to allow your beneficiaries to reach financial independence? (See the box below for my thoughts on this.)
- If you’re single, do you want to leave a life-changing gift for a non-dependent loved one?
I recommend taking your time with this step before moving on to the others. It’s important to get very clear on what you want your beneficiaries’ lives to look like should you pass away.
Doing so helps to ensure that you won’t spend more than necessary on life insurance. Or worse—leave your beneficiaries with an inadequate payout at their time of greatest need.
Reaching FI with… life insurance?
When my husband and I discussed our life insurance options, we agreed that we didn’t want the survivor to have to go back to work. Instead, we wanted the remaining spouse to reach FI with the death benefit.
In the short term, this would give the survivor time to grieve, care for the kids, and deal with the estate. In the long term, it would give them all the flexibility they’d need to consider what the rest of their life will look like.
Interestingly, in all the years that we’ve been buying life insurance, this scenario has never been discussed as an option! It’s always assumed that, after a period of mourning, the survivor will go back to work.
I acknowledge that some people do genuinely want to go back to work. They may want the distraction, purpose, and routine of returning to the workforce. But even if that was the case, wouldn’t it be nice if going back to work was a choice and not a necessity?
That’s why I suggest purchasing enough life insurance to allow the surviving spouse to reach FI. That way, the decision to go back to work (or not) is 100% on their terms.
Step 2: Calculate your FI number
Your FI number is how much you need to have invested in order to achieve financial independence. I’ll go over how to figure out your FI number below.
But first, a caveat—depending on your situation, your FI number may or may not be important in your life insurance calculation. You can jump to Step 6 to see some scenarios when your FI number may not be necessary.
If you find that your FI number will be needed for your life insurance calculation, here’s a quick way to do it: annual spending x 25 = FI number
For example:
- $40,000 annual spending x 25 = $1,000,000 FI number
- $60,000 annual spending x 25 = $1,500,000 FI number
- $80,000 annual spending x 25 = $2,000,000 FI number
For more on how to calculate your FI number, see my post, 4 Simple Steps to Financial Independence.
Once you’ve worked out your FI number, make a note of it, then move on to the next step.
Step 3: Add up your debts
If you have any debt, it should be factored into your life insurance calculations. But how you factor it in will depend on how you intend to handle it:
- Will the survivor keep the debt as a regular expense that’s built into their FI number?
- Alternatively, would they prefer that the death benefit cover some or all of the debt?
- If they keep some or all of the debt, do they want to pay it off slowly or as quickly as possible?
- Will they treat all the debt the same, or will certain loans (such as the mortgage) be separate?
Add up any debts that you’d like paid off by the death benefit, then save the number to add to your life insurance calculation.
For debts you’d like to maintain as a regular expense, add up the payment amounts, then save the number to use in the next step.
More info on life insurance
For more info on life insurance, here are my previous posts on the topic:
Step 4: Add in the extras
This step is optional—think about all the extras or ‘nice to haves’ that you’d like your death benefit to cover. Some ideas for extras include:
- A buffer for unexpected expenses.
- Gifts and donations.
- Tuition and school expenses.
- Final expenses (funeral, taxes, etc.)
Add up the cost or dollar value of all the extras you want to include in your coverage, save the number, then move on to the next step.
Step 5: Add up assets and future income
To ensure you don’t over-insure yourself, you’ll need to factor in all the assets and future income you’ll have or receive. This could include:
- Workplace life insurance policy.
- Retirement accounts.
- Investment accounts.
- Workplace stock options (ESPPs and/or RSUs).
- Bank accounts.
- Term deposits.
- Educational savings accounts such as RESPs or 529 plans.
- Children’s informal trust accounts.
- Investment properties.
- Residual income (such as from a rental property).
- Your primary residence (if you plan to sell it).
Create an inventory of all your assets and sources of income, then add them up. The total could be significant, and will help to decrease how much life insurance you’ll require.
This is the last number you’ll need—you’re now ready for the sixth and final step!
Step 6: The final calculation
You’ve worked through all the previous steps, and are all set to calculate how much life insurance you need. Here’s the calculation: FI Number + Debt + Extras – Assets = Coverage amount
Adjust as needed
You can also adjust the formula as needed. For example:
- Single with no dependents: Debt + Extras – Assets = Coverage amount
- Partner will continue working: (FI Number ÷ 2) + Debt + Extras – Assets = Coverage amount
- Single with kids: X years of kids’ living costs + Debt + Extras – Assets = Coverage amount
- Just the basics: Debt – Assets = Coverage amount
And that’s it—you now have a solid number to use when getting life insurance quotes.
Bonus tip: Optimize your coverage
As a FIRE seeker, you’re likely an optimizer like me. To make the most of your money, you should revisit your expenses regularly (including your life insurance) and trim them back as needed.
You may be able to reduce your life insurance coverage if:
- You’ve paid down your debt.
- Your investments have grown.
- You’ve attained new assets.
- You’ve added a new residual income stream.
My husband and I reduced our life insurance coverage every two years as we got closer to FI. In turn, we invested the savings, which helped us reach FI faster.
However, don’t be too hasty when reducing your coverage. Remember that when you first purchased your policy, you were that many years younger.
As we all know, age is a big factor in calculating life insurance premiums. You’ll never again get your policy as cheaply as you did originally!
Therefore, if you change your mind and want to increase your coverage later, it could cost you a lot more. So, proceed thoughtfully when considering a reduction in coverage.
Summary
If you want to ensure your loved ones are taken care of after you pass away, life insurance can help with that. However, it’s crucial to purchase the right amount. You neither want to be over nor underinsured.
By going through the six steps in this post, you’ll arrive at a number that’s just right and tailored to your situation. In addition, it’ll be based on your actual needs and wants—not on an arbitrary multiple of your income.
Once you calculate how much life insurance you need, you’re ready to get some quotes. (I would suggest PolicyMe; not only are their rates competitive, but their quoting process is quick, easy, and all online.)
Related: PolicyMe Review—Canada’s Best Way to Buy Life Insurance
Share your thoughts and questions
If you purchased life insurance in the past, how did you figure out how much coverage you’d need? Are there factors you included that I didn’t cover? Or, if purchasing life insurance is new to you, do you have any questions?
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4 Comments
Christopher Mercanti
February 1, 2023 at 5:39 amThis is a really helpful overview, Chrissy – Many thanks!
Chrissy
February 1, 2023 at 10:02 pmHi Christopher—I know life insurance decisions can be confusing and overwhelming, so it’s so nice to hear my post was helpful!
Teresa
February 10, 2023 at 7:21 pmChrissy is so detailed that I could have learned from her back when I was young and had a young family! When we had a mortgage, we bought enough life insurance to pay off the mortgage if dad or I passed away before our children grew up. One day I heard a guy on a talk show and he said that couples made the mistake of buying more insurance to cover a father’s life when it is more important to buy more to cover the mother’s since a mom used to work as well as tend to housework, cooking and childcare. It is so wonderful to see how much information Chrissy has shared since there are so many different family situations out there! 70’s was a different life for sure! There are so many more options out there including FIRE!!!
Chrissy
February 10, 2023 at 8:29 pmHi Mom—I’m glad we had your advice when we bought our first life insurance policy. As you mentioned, our agent at the time focused more on covering the life of the father.
So, he suggested a large amount if M passed away. But he didn’t take into account the cost of replacing my “labour” of raising the kids and running the household.
Therefore, he suggested a very minimal amount to leave for M in case I passed away. His assumption was that M could just go back to work and pay for childcare.
I wasn’t as financially savvy back then, so I was grateful that you brought this up with us before we bought that policy. It could have been awful for M and the kids if we’d listened to that agent and I passed away.
Anyway, I’m glad we live in an era where there’s so much great personal finance content out there. I’m hopeful that it’s helping to improve the rate of financial literacy in the general public.