Why is a One-Million-Dollar Life Insurance Policy Important?

Most Americans earn under $100,000 a year and many of them earn below $25,000 to $75,000 per year. According to Statista.com, almost half of Americans earn between $55,000 to $99,000 a year. Of that distribution, about 17% earn between $50,000 and $75,000 a year. Let’s average things out a bit and use an annual income of $50,000 in our example below.

If we were to recommend to the average person that earns around $50,000 a year, a one-million-dollar life insurance policy, most of them will say that is too much life insurance: we know because we recommend one-million-dollar life insurance policies all of the time. After all, many individuals and business owners earn or pay themselves around this amount annually. 

When it comes to income replacement, it is normally recommended that you have 10 to 20 times your annual income in the form of life insurance death benefit. In our experience, the number is closer to 20 times your salary to remain conservative. We take our income replacement logic step further and use a rate of return approach, which reveals the reasoning for our recommendations.

Let's Crunch the Numbers Down...
Let’s use basic algebra to determine how much death benefit at a reasonable annual rate of return it would take to replace a $50,000 salary. Even though the major stock market indices tout an inception to date annualized growth rate of over 10%, it wouldn’t be too conservative to use such a figure. Conversely, it wouldn’t be the best idea to drop all of one’s windfall of money into a bank in 2020 at 1 to 1.5%…especially if the goal is to replace a salary – so, let’s meet in the middle with 5%.
Our formula is [Replacement Income = Expected Rate of Return x Death Benefit]. We are trying to solve for the Death Benefit and already have the example values for our expected rate of return and the income we need to replace. Therefore, with some freshman high school algebraic manipulation, our formula becomes [Death Benefit = (Replacement Income/Expected Rate of Return}]. Dropping in the known numbers from above, we have [Death Benefit = ($50,000/.05)] = $1,000,000.
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Therefore, it takes $1,000,000 in death benefit at a conservative expected annual rate of return of 5% to replace a gross salary of $50,000 a year. Sometimes this is the base figure used. The income replacement strategy in theory should replace the lost income of which a portion was being used to pay down debts, such as a mortgage. 
It’s not uncommon to include large debts like a mortgage into the death benefit of a policy, or using a combination of Permanent and Term Insurance to achieve the goal. Buying $1,000,000 permanent insurance that grows cash value over time, such as Universal Life or Whole Life insurance, may prove too costly for the average budget. But using a combination of permanent and term insurance may achieve the goal of income replacement with some additional debt downplay.
Let’s look at a Hybrid Permanent and Term Insurance
Going off of the assumption that we are working with a $50,000 income replacement need and that a $1,000,000 life insurance policy is a lot more common than normally assumed, how can we split things up a bit to get a little more bang for our million bucks? Generally, Term Insurance is the cheapest insurance option, as it is like renting insurance. Depending on your age, you can get term insurance with guaranteed terms ranging from 1-year renewable to 5, 10, 15, 20 or 30 years. 
Most term policies have a term convertibility privilege, which allows the policy owner to convert some or all the policy into a permanent policy. We will refer to this as a ‘rent-to-own’ deal. After the term is up on most term insurance policies, assuming that they are not converted to permanent policies within the contractual time frame, they become 1-year renewable term policies up until the contractual expiration of the policy. This means that the term with a guaranteed non-changing premium no longer applies…now, the insurer will raise rates annually based on the insured’s age and medical rating. This is known as an annual ‘cost of insurance’ or COI increase.
Permanent Policies are Universal Life and Whole Life Policies; both policies have their own unique variations, but we will remain general for simplicity sake. These are the ‘ownership’ policies, as the owner of such a policy remains the owner for the life of the insured and controls the cash value accumulated until the insured passes. It goes without saying that these are the most expensive policies, with Whole Life being the most expensive of the two, due to its guarantees.
Permanent insurance has Option A and Option B. Option B is cheaper as the death benefit remains the same, therefore the amount of risk to the insurance company remains the same. With Option A the net risk to the insured increases and the death benefit can growth in the policies over time, by amounts that vary on a policy to policy basis. If structured properly, an insurance agent can help a couple with an income replacement goal pay down their mortgage in the most effective way.
If a Mortgage is currently $300,000 for the next 20 years, an additional term insurance policy for $300,000 for 20 years can be purchased or the one-million-dollar life insurance policy can be split into a portion term and a portion permanent, with the permanent portion being elected as Option A so the death benefit grows overtime to the point where it eventually covers the mortgage also.
In summary, the next time you speak with an insurance agent or if you call us for help on identifying the amount of coverage and type of insurance that would be best for your family, don’t be surprised when there is 6 zeros behind our quote or illustration!

I have known the proprietor of East Coast Financial for over 20 years and from the day I met him, to shortly after when he managed my money, I knew he and his organization is one I could trust.

– Robert Leaman | Retired | Former Owner Compressed Gas Solutions

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Why is a One-Million-Dollar Life Insurance Policy Important?
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