A Reader Asks #6

This comment was left on the post What Happens When You Die?

Art- Thanks for your answer about indexed annuities a while back. This issue is something that most young individuals do not want to think about, but what do you recommend for a young couple or young family in deciding how much is enough if one of the income earners dies or becomes disabled? Thank you.

Thank you for your readership, support, as well as your question.

When it comes to preparing for a potential death or disability, any couple or family has to consider what the economic impact would be. In both cases we need to consider both the lost wages as well as changes in expenses. While the process is the same, the answers may be different when looking at a death as compared to an extended disability so we will look at each separately.

Preparing for a Death

It is a myth that household expenses will decrease proportionally with the death of a family member. Some budget areas can decrease such as clothing and food, but not necessarily proportionally. I remember when my wife and I became a family being surprised that food expenses did not double. After some consideration I realized that we were able to enjoy an economy of scale buying food for two people. For example, I used to buy about a quart of milk a week. Together with my wife we started buying the gallon size which had a lower cost per ounce. If I died, the reverse would also be true. Other areas of a family's budget are not paid on a "per person" basis such as housing costs, property taxes. There are some expenses which are both such as utilities. With one less family member there would be less water and electric use, but heating and air conditioning costs would remain about the same.

The best place to start is a record of the families spending over the past year. For every category the couple should discuss how that spending would change if one of them died. At the end of the discussion they should have a viable "survivors budget" which reflects the lifestyle the survivor would want to lead if they were widowed. Don't forget to consider new expenses like an increase in daycare or baby sitting.

Finally, compare this survivor budget to the survivor's income. Would the surviving spouse's income support the planned expenses? If not, life insurance to cover the difference would be appropriate. There are a couple of different ways to convert this income shortfall to a death benefit and this is one reason to seek professional assistance. But for those comfortable doing it I would recommend a time value of money calculation (but be sure to factor in inflation).

On top of the income needs add final expenses such as funeral costs, education funds, and possibly even charitable intentions. The sum is the amount of life insurance needed.

Preparing for a Disability

Financially, an extended disability can be even more devastating than a death. Many people have disability benefits of some kind through their employer, but few employees ever take the time to understand their benefits … until they need them. The first step is to take the time to understand what your existing coverage will (and will not) provide.

Expenses definitely do not decrease in a disability. This usually means an increase in utilities as well as medical expenses. Often the able family members take time off of work to provide care, which causes their income to decrease.

Once again a family should start with their spending history, and adjust it to anticipate a disability. Then compare the results with the expected income. If there is a shortfall, the good news is you can purchase disability income protection for the exact monthly income you will need.

Conclusion

I fear you were looking for a definitive answer instead I gave you process. The truth is there is no universal truth. I can not tell you how to protect your family until you know what you want to have happen. Two income families are not uncommon. I submit for your consideration that in most two income families, both incomes are needed. The family will need to adapt to a new lifestyle if they are forced to live on one income.

Resources

• How Much Life Insurance Do You Really Need?
• When Staying Alive Means Going Bankrupt
• Disability Insurance: How Much Do I Need?
• Protect Your Most Important Asset With Disability Insurance

Do you have a question you would like to ask? If so, just email me. I will answer it here on the blog but will remove any personally identifiable information. Or, if you would rather I not post the answer, just let me know and I would be happy to keep your question and my response confidential.

Photo on flickr by chona kasinger