Life Insurance vs. Self Insurance
Life insurance is a way to provide for your family if you die while they are still dependent on your income. When you buy a policy, you pay premiums, and in the case of your death, your beneficiaries are paid a death benefit.
The death benefit is determined when you purchase the policy. The benefit amount should ideally be enough to make your family whole in the event of your death — to pay off your mortgage, pay for your children’s education, even fund a taxable account for your spouse’s retirement.
But not everyone needs life insurance. Some people have enough assets that their dependents will be okay financially even the breadwinner dies. These people are considered to be self-insured. Having a self-funded plan means having enough cash to be able to cover everything your dependents may need or may ever need without a life insurance policy in place. Self-insurance is possible for people with huge assets but also for people with low expenses.
What does it mean to be self-insured for life insurance?
Complete self-insurance means that, in the event of your death, your family would be able to cover all of their expenses and financial needs with your assets. There would be continued cash flow regardless of your ability to earn an income.
How do you know if you can be self-insured for life insurance?
To figure out if you can actually afford to be self-insured, you need to look at your assets and costs.
Here’s an easy formula to know if you can self-insure for life insurance: Amount your family may need if you die = Amount you have in liquid assets
To figure out how much your family would need if you die, it’s useful to use a life insurance calculator, which can help you think about future and present expenses.
Depending on your family situation, the amount your family needs could be as low as a few thousand dollars for a funeral or as high as the balances of multiple mortgages, the tuition needs for multiple children, retirement needs for your spouse, and more.
A retiree who has paid off his mortgage and whose spouse has her own retirement savings may be able to be self-insured for life insurance simply by having enough money saved to pay for his funeral. On the other hand, a young parent may need millions of dollars in liquid cash to be sure her family would be taken care of in case she died.
How term life insurance can help you be self-insured
For many, the easiest path to being self-insured is through term life insurance.
Buying life insurance to be self-insured seems counterintuitive. But few people can be self-insured throughout their entire life.
Most people’s expenses look like a bell curve over time. When you’re young, you don’t have many things that you would need to be covered if you die besides a funeral (though for some people with private student loans, this may not be the case).
When you buy a home and have kids, your expenses rise with tuition, mortgage, and child-care costs. Then, once the kids are out of the house and you’ve paid off your mortgage, your expenses go back down.
Term life insurance can get you over that big middle hump and back to the other side where your expenses are low again – at which point you can start self-insuring.
Not sure how much life insurance you might need?
How to become self-insured for life insurance
For the amount you have to be enough for you to self-insure, it’ll have to grow. To do that, you need to manage your money wisely over the years:
Have a budget in place. You don’t want your chance at being self-insured to die by a thousand cuts (or, in this case, a thousand dinners out). Budget your money wisely, so you aren’t wasting it frivolously, leaving you anything to work with when your term life insurance policy expires. A simple spreadsheet or several apps can help you build a budget that fits your lifestyle and still leaves a little leftover. Invest wisely. What should you do with that money you’ve saved up? Invest as much of it as possible. The earlier you start, the better off you’ll be. There are a lot of ways you can do this, and it’s good to diversify.
Make sure some of it is in short-term investments that you can easily and quickly access if you need to.
Look to long-term investments that you can let sit for years (or decades), so the returns will compound, and you can see it grow.
Contribute to retirement accounts in particular. If your employer offers a 401(k), look into it (especially if they’ll match contributions). Use an IRA. Start saving with a 529 college savings plan, so you have money earmarked specifically for education. (For your retirement accounts to self-insure you -- meaning that they go to your loved ones after you die -- make sure you add a beneficiary to them — or else they get probated through your estate — and update those beneficiaries as often as you need to.
As your money grows, the amount you’ll need to rely on life insurance will decrease – and once it’s gone, you’ll have enough to be self-sufficient.
Being self-insured isn’t necessarily complicated – it can just be difficult to get to that point. Buying life insurance is the easiest way to make sure your family is protected until you get there.