Investment Workshop 16: Insurance

A reader recently asked us “Can you do a post on insurance? I have no idea how much insurance I need.” Which is a great question. Insurance is something we often don’t talk about in personal finance blogs, but is something everyone has to do deal with.

In my experience, when it comes to how much/what types of insurance people own, they usually fall into two categories:

  1. Over optimistic idiot who doesn’t own ANY insurance even though they should
  2. Overly pessimistic scaredy-cat who owns WAY TOO MUCH insurance than they need

We actually know both types of people. There’s the homeowner friend back in Toronto who rants and raves about how much her condo has appreciated in value every time we go out for lunch, yet doesn’t own any home insurance because all her money is going towards the mortgage and there’s nothing left over for anything else. She is one fire or burst pipe from financial ruin and refuses to do anything about it. She is underinsured.

And we have another friend who pays hundreds of dollars a month on life insurance despite the fact that he’s single and has no kids. He is overinsured.

But I’m not gonna yell at these people for being idiots, because it’s not that easy to figure out how much insurance you actually need. They sure as Hell don’t teach it in school, so the only authority available on how much insurance you need is left to insurance salesman. And from them, the answer is always “As much as I can trick you into signing up for.”

So we are left with Goldilocks scenario. Too little insurance and you may get wiped out financially. Too much and you’re wasting money. So how much is “just right?”

Shoulda bought Bear Insurance before this happened, dumbass.

To answer this, we will break down the different types of insurance most people have to deal with into 4 categories:

  1. Life Insurance
  2. Medical Insurance
  3. Asset Insurance
  4. Travel Insurance

Life Insurance

Life insurance is an insurance contract where if you kick the bucket while shark-surfing, or whatever awesome thing it is that you do in your spare time, your family gets a lump-sum benefit to provide for them while you remain unable to work (you know, because you’re dead).

You’re calling in dead AGAIN? Typical Lazy Millennial…

So do you need this? Well, obviously if you’re not married or have any dependents, then the answer is no. But if you do, it gets a little trickier.

While Working Towards FI

When you’re still working and savings towards FI, it does make sense to purchase life insurance. However, and this is a BIG however, you don’t want to purchase too MUCH life insurance.

Let me explain.

You may have noticed that in the many reader cases we do on this site, one of the first things we calculate is the reader’s “FI Number,” meaning the portfolio size they need to hit to be able to retire. This is typically calculated by taking their annual expenses and multiplying by 25, as per the 4% rule. So someone spending $40k a year will need $1M, someone spending $50k a year will need $1.25M, etc.

So let’s say your FI number is $750k and you currently have $250k saved. This means you need to save $500k to get to your FI number, and given your current savings rate you should be able to get there in about 10 years.

So how much insurance do you need? The answer is just enough to get you (and by that, I mean your surviving family) to your FI number in case you get run over by a car. So you need $500k of coverage over the next 10 years. That way, if you make it, you win. And if you don’t make it, your family is still taken care of.

So you should purchase Term Life Insurance. Term Life Insurance covers you for a specific period (or term), and for a specific coverage amount. In this scenario, you should purchase a Term Life policy with a coverage of $500k (the amount you need to become FI) for a duration of 10 years (the amount you think it will take to get there on your own). Other insurance products like Permanent/Whole Life or Universal Coverage are meant to cover you for your entire life, but you don’t need that much coverage.

Why? Because you only need that insurance coverage over the set period of time it will take you to become FI, not your entire life. And because of this, your insurance costs will actually be very low. I plugged in this data into State Farm’s website and I got a cost of…$32 a month. By comparison, Permanent Life Coverage from the same company cost $615 a month, or 20X MORE!

Figure out how much coverage you need, and don’t pay a single penny more than you have to. If you’re paying more than $50 a month, you are doing something seriously wrong.

Cost: $30-$50 a month.

After Retirement

Here’s the fun part. After you retire, you do NOT need Life Insurance at all.

Got it? Zero. Zip. Nada.

That’s because your portfolio acts as your life insurance. In retirement, your portfolio, not your job, provides you enough income to live via your Yield Shield, so your family is provided for whether you’re physically there or not. So life insurance is redundant.

Cost: $0

Medical Insurance

Medical Insurance is, depending on where you live, either ridiculously complicated (*cough* AMERICA *cough*), or ridiculously simple.

If you live in a developed country outside the USA like Canada, the UK, Australia, etc, you can pretty much just skip this section. You’re good.

For Americans though, this is a tad more complicated…

While Working Towards FI

While you’re working, your health insurance should be covered by your employer. However, your employer doesn’t pay for your entire health insurance premium, and instead shares the cost with the worker. Typically, the employer picks up about 70-80% of the tab, leaving the worker having to contribute the rest. On average across the US of A, this is about $5000 a year per household, or $420 a month according to the Kaiser Family Foundation.

And of course, for everyone else with a single-payer health care system, your health insurance is paid for by your taxes, so the additional cost for you guys is $0.

Cost (USA, National Average): $420 a month

Cost (Everyone Else): $0

After Retirement

In the past, if you didn’t have a job (or had a job, but also a pre-existing condition) the American health care system would simply wish you the best of luck in your future (and likely, brief) endeavours.

But after the implementation of ObamaCare, the situation is considerably better for Early Retirees. This is because ObamaCare offers federal subsidies (and expanded Medicaid, for the states that implemented it) that were income tested rather than means tested. This means that Early Retirees can now access health care plans at way cheaper prices.

This is all due to the fact that once you retire, your earned income drops dramatically and qualifies you for federal subsidies. Our good friend Jeremy from GoCurryCracker wrote an excellent analysis of how to optimize Obamacare in Early Retirement, and plugging my own information into an Obamacare calculator, I got a monthly premium of $200 a month, but this could be much less for you depending on your MAGI and number of dependents. I’ve seen it as low as $50 a month.

And of course, for everyone else with a single-payer health care system, your health care is guaranteed as a basic human right whether you work or not, so your cost is $0.

Cost (USA, National Average): $50-200 a month

Cost (Everyone else): $0

Asset Insurance

And finally, we come to Asset Insurance. These are the insurance policies you take out on your fixed assets (like a home or a car) to insure you from financial loss in case that asset spontaneously combusts.

Right. “Spontaneously.”

Let me get this out of the way: Yes, you should insure your major fixed assets like your house or your car. You don’t want the majority of your net worth to get wiped away by that evil-looking girl up there.

But on the other hand, as we write endlessly on this weird little blog of ours, if the majority of your net worth is tied up in a house or a car, you’re probably not going to EVER retire.

This is because money tied up in a house or a car can’t be used to fund your living expenses. That’s the reason why in our case studies we exclude home equity from contributing towards a person’s FI number.

So on home/car insurance, as long as you own those things, YES, you should definitely insure them to protect your investment. But unless your home/car is a small fraction of your net worth, you’re going to need to sell it to unlock your equity and help you retire. Otherwise, you’ll have to keep paying to insure it forever (as well as property taxes, maintenance, utilities, etc.), possibly delaying your retirement indefinitely.

We never owned property, or a car, so our insurance cost was $0.

Cost: $0 (ideally)

Travel Insurance

Obviously, this only applies to people who are like us who travel nomadically. If your plan in retirement is to stay in your home country, this doesn’t apply to you.

Travel Insurance is meant to cover your health care costs while you are away from your home country. Even if you are in a country with universal health care, since you’re not a resident you typically have to pay out of pocket. For things like checkups or teeth cleanings, this isn’t a big deal since those things are usually much cheaper abroad than in North America, but if something really bad happens and you fall and break your leg or you’re diagnosed with something more serious (knock on wood), Travel Insurance will prevent you from going bankrupt as a result. I know a couple who gave birth prematurely while travelling in the US and the entire ordeal (the birth itself, complications from being premature, extended hospital stay, and medevac back to Canada) ended up costing about $1M! But because they had Travel Insurance, the were OK.

We’ve been using SafetyWing for Travel Insurance and they are one of the few companies that offer “Worldwide” travel insurance for an extended period of time. When we travel, our insurance premiums typically come out to about $45 USD a month per person.

Cost (if living nomadically): $45 a month/person

Cost (if staying in home country): $0

Expat Insurance

Note that travel insurance is meant to be a supplemental insurance that covers you while you’re travelling on a temporary basis. It assumes that you have health insurance in your home country, so if something really serious happens, it will pay to fly you back home, at which point your normal health insurance is expected to take over.

If you don’t have health insurance in your home country, you need expat insurance, which is actually a full-fledged health insurance plan with a much higher coverage limit of $1.5M. It’s a subtle but important distinction, so make sure you’re properly covered.

Safetywing’s expat insurance is called Nomad Health, and starts at $125 per month.

Conclusion

So there you have it. Insurance: Who needs it? You do! But only enough coverage to protect you, and no more.

As a Canadian who retired at 31 and travels the world (and therefore doesn’t own a house or a car), our insurance burden is just $90 USD a month for the two of us (we have travel insurance, but that’s it). As an American, you have to pay some health insurance premiums, but thanks to ObamaCare it doesn’t have to break the bank and your dream of Early Retirement is still possible.

Onto the next section!

Go back to the previous section


WORKSHOP TOOLS

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Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.


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