<< Understanding Basic Insurance Needs

Who Needs Life Insurance?

If you have people that depend on you financially (e.g. spouse, children, or possibly parents), you need life insurance. Life insurance comes in two main types, “Term” and “Permanent.” 

Term Life Insurance

Term life insurance lasts for a specified term (usually between 10 and 30 years), typically has a fixed monthly or semi-annual premium, and provides a lump sum benefit to your beneficiaries when you die. This lump sum benefit is typically tax free. Term insurance is the most common type of life insurance, is reasonably priced (although your health and lifestyle can affect this), and according to experts is the right choice for most people.

Permanent Life Insurance

Permanent life insurance lasts for the entire duration of an individual’s life as long as the premiums are paid. It consists of both a death benefit and a “cash benefit.” The cash benefit is essentially a savings vehicle. Typically, part of your premiums are invested and you can receive some of the returns if you cancel your policy. Sometimes you can even borrow against your invested assets. Permanent life insurance policies are more complex than term policies and on average your premiums will be 6-10x more expensive. 

There are reasons that both types of insurance can be good depending on your situation. But Term life insurance is much more common due to lower premiums. Additionally, the invested cash value you can get from a permanent life insurance policy is unlikely to be the best way to invest those dollars. In other words the standard recommendation is to buy cheap term life insurance and invest the difference in the premium prices in other ways if you’re able to.

The amount of insurance you need is often calculated at 10x your annual salary. Some people get a little more detailed and will add in things like debt owed and higher education expenses that they plan provide for their children. But some version of the “10x salary + other expenses” is a good rule of thumb to estimate how much life insurance you need.

Significant Insurance Types to Consider

• Life – if you have financial dependents, you need this insurance. Most people get “Term” life insurance but a minority of people will get “Permanent” (sometimes simply called “Whole”) life insurance.
  

• Auto – if you own a car you need car insurance and the “Liability” component of car insurance is legally required in most states.
  

• Home – this protects your home and may also provide a layer of liability protection for certain types of accidents – sometimes even ones that didn’t happen on your property.
  

• Renters – this can provide protection for your belongings, costs associated with water damage, temporary housing if your unit becomes unlivable, liability protection and more. 

• Disability (LTDI) – this provides a level of income replacement should you become disabled and unable to work. It may be offered through your employer.
  

• Long-term Care (LTCI) – this provides payouts for specific costs associated with skilled nursing or facilities should you require these for health-related reasons.
  

• Umbrella – this provides an extra layer of liability protection (beyond what you may have with home or auto) in the event someone tries to sue you for an accident.

Details

Your focus is to become financially independent and you have worked incredibly hard to reach this stage. But unforeseen events and accidents happen. If you’re not prepared, everything you’ve worked for can be put at risk in a matter of moments.

But here’s the good news: Each type of insurance listed above is easily understood, and easy to acquire. Additionally, relative to health insurance, these types of insurance are comparatively inexpensive.

Some of these insurance types can be purchased and bundled together with your traditional “Home, Auto, Life” companies (and bundling usually saves you money). Others can be purchased through your current employer. (Important: If the policy is paid through your paycheck it will become inactive when you leave that job.) Finally, some insurance types are most easily purchased through an insurance broker.

Action

If any of the insurance types above might make sense for you, click their links to learn more. If you decide you need that type of insurance, add the task to your plan.

The Why & What

Before you can calculate your emergency fund needs, you first need to consider its purpose, and then the associated expenses.

Common Emergency Fund Purposes

When you first start emergency fund, it’s perfectly acceptable to consider it only for true, unexpected expenditures. However, as your financial health matures, so does the purpose behind your emergency fund. Now that you’re in the Independence tier of financial health, you are likely bolstering your emergency fund to a final number (future adjustments for inflation notwithstanding). Therefore, it’s worth taking a quick look back and considering how the purpose of your emergency fund may have changed over time.

Which of the following do you want your emergency fund to be able to provide for?

• Unexpected Expenses: Your fun can cover one time (or infrequent) high cost expenses like auto repairs, home repairs, medical expenses and more.
  

  When you calculate your emergency fund goal, do you want to include for some time off or a major change in your career?

• Loss of Income: Your fund can cover income lost from a job. 
• Loss of Benefits: Your fund can cover the cost of certain important benefits that may come with a job such as health insurance.
• Savings Goals: Your fund can cover all your normal expenses and your planned savings goals (both long-term and medium-term).
• Job Freedom Fund: Your fund is large enough that you’re comfortable quitting your job at a moment’s notice while you explore other opportunities for work or fun. (Some great tips here!)
• Provide Family Help: Your fund is large enough (and you’re willing) that you could help a family member or close friend that needs financial assistance.

From initially covering only unexpected expenses to eventually acting as a job freedom fund or a fund to help cover other people’s unexpected expenses, it’s not hard to see the evolution.

Calculate Emergency Fund Expenses

Prior to an emergency, it’s important to be realistic about expenses you could cut back on vs. fixed costs that you have little to no control over.

As with all budgeting calculations, you can either focus on category by category spending, or you can look at the last several months of statements from your accounts. For the second method, add up the total charges and divide that number by the number of statements you included. This is often the most accurate method for understanding your true expenses. But whether you go the account method or the category method, take a moment to consider the categories below and how “fixed” or “flexible” they may be.

• Food

• • Groceries
    

    To calculate your emergency fund it’s great to consult a list of possible expenses to make sure you haven’t forgotten anything.

  • Dining out
  • Food Delivery

• Housing

• • Rent or mortgage payments
  • Utilities including gas, electricity, internet, trash, water etc.
  • Maintenance costs

• Insurance

• • Health
  • Auto
  • Home

• Transportation

• • Gas
  • Maintenance
  • Insurance

• Other

• • Cell phone plan
  • Subscription services (television, news subscriptions, shopping etc.)
  • Childcare

• Savings & Debt

• • Contributions to long-term savings (retirement, child’s educational fund etc.)
  • Minimum payments – or more – to debt including low, medium and high-interest

Take Action

First, ask yourself, “What do I want my fund to cover?” Secondly, calculate your monthly costs, and then multiply that by the total months you want your fund to cover. And finally, write the results down in the notes section above (for logged in users).

Something Larger than a 6 Month Emergency Fund?

In the Growth stage, you grew your emergency fund to between 3 and 6 months of living expenses. In doing so you provided the security you needed to have a solid financial backstop should something unexpected happen. If you continue to build beyond a 6 month emergency fund in the Independence stage, it will be due to some combination of the factors listed below.

Evaluate the factors below and use them as a guide to determine if and by how much to grow your emergency fund.

Personality

Based on personality alone, some may only feel secure with a year’s worth of living expenses socked away. For others a six month emergency fund is plenty.

There’s no right or wrong choice. However, if you choose not to grow your emergency fund beyond six months, take money you previously saved toward that goal and invest it in something likely to generate a good return over the long term (like a low-cost index fund etc.).

Purpose for Your Emergency Fund

If the purpose of your fund is only for truly unexpected emergencies – an auto repair, medical costs not covered by insurance, necessary but unexpected travel etc. – you may feel comfortable with a relatively smaller amount. But if you consider your fund for things beyond emergencies, a larger fund may be needed. For example, wanting the freedom to quit your job, take time off, go back to school, or cover emergencies for a loved one are all reasons you may want a larger fund. Only by considering the purpose of your fund, can you really determine how large it should be.

Changing Life Circumstances

As your life changes over time, it important your emergency fund evolves to fit these circumstances. Consider these examples of changing life circumstances:

• Volatile Job: You’ve landed a great job! Unfortunately, you recognize it’s in a volatile industry where ups and downs, layoffs, or even company closures are common. While you have no plans to leave your job, it may be beyond your control.
• Living on Your Own: Shortly after moving out of your parents house you wouldn’t have minded moving back in if your financial circumstances necessitated it. In other words, your parents acted as a financial backstop. But now, you’ve grown beyond that and couldn’t imagine having to move back in. 
• Children or Other Financial Dependents: We all know that children are expensive. But financial dependents can also take the form of aging parents who can no longer live fully independently and need support. This could be in the form of in home care, someone to help with errands and more. Your emergency fund may be able to help bridge the gap.
• Dual-income Household: Becoming a dual-income household is one of the few circumstances where your emergency fund can become smaller relative to your total household expenses. With two income streams, you’ve spread out the risk that all your income will disappear over night.

These are just a few examples of changing life circumstances. Some circumstances can change overnight whereas others evolve slowly over time. But whatever the circumstance, these life circumstances may necessitate a larger emergency fund than you previously planned for.

Other Goals

If your emergency fund account also holds money for other purposes – for example a home downpayment, home remodel, new car fund etc., it’s important to remember that as soon as you use that cash for those purposes, it won’t be available for emergencies. If your emergency fund account is split into clearly delineated buckets (some banks like Ally Bank and others allow you to do this), this may not be a problem. But if not, it may be wise to build up an “emergency fund” that is closer to a year’s worth of expenses to ensure all your needs and goals are met.

Take Action

Make a note that defines the purpose of your emergency fund and how large you want it to be. Finally, follow the next steps in your MoneySwell plan (logged in users only) to get closer to your goal.

Congratulations!

You’ve reached the beginning of what is arguably the most interesting and rewarding tier of financial maturity: Independence. In this tier, you are now firmly focused on reaching some version of “Financial Independence.” You have the expertise to manage your day to day finances, you have the security of a solid emergency fund, you have wiped out your high and medium-interest debt, and you have taken solid steps to save for your long-term future.

However, you are not financially independent yet. Specifically, you do not have the passive income and savings available to support yourself for the rest of your life. You still need to trade your time in order to earn income. Additionally, you still need to invest a portion of your income in a way that will allow you to earn future passive income (e.g. by owning a rental property, selling an online course etc.), or, investing some of your income so you can eventually draw down those savings directly (e.g. by selling stocks you purchased, taking cash out of accounts etc.).

Finding Your ‘Whys’ and Your ‘Whats’

Before you dive into trying to reach “Financial Independence,” take a moment to reflect. For example:

Why are you pursuing financial independence?

• Do you want to have the time to travel, learn a new skill, or spend time on a hobby or other passion?
  

  Research has shown that visualizing your goals can actually help you to achieve them.

• Do you want to leave your existing job and pursue something that may be less lucrative but more in line with your interests?
• Do you want to continue in your existing job but use your secondary passive income to support a family member or close friend?
• If you’re looking to retire early is it so you can pursue interests that may be harder to do when you’ve reached typical retirement age (e.g. adventure travel etc.)?

What will you do when you reach financial independence?

• What will a typical day look like when you have reached financial independence?
• Will you do more of things you already love doing or will you completely reinvent yourself and your lifestyle?
• Will your lifestyle cost a similar, greater, or lesser amount compared to your existing lifestyle?
• Do you define financial independence as never having to work at all or does it just mean being able to drastically reduce your work or change the type of work you do?

How will you manage common situations in financial independence?

• Do you want to be completely debt free or will you be comfortable with low-interest debt so long as you have reliable income to pay it?
• Will you need to acquire health insurance on your own and will it meet your needs at a reasonable cost?
• Will you need or be able to get loans for large purchases based on the type of income you have?

Finding Your Balance

Once you have a clear idea of why financial independence is important to you and have a good idea of what your life will be like when you reach that stage, you can begin to think about what sacrifices you are willing to make now, so you can achieve your financial independence dreams later. For example:

• Expenses: How much would you be willing/able to reduce your expenses now in order to invest in your future? What types of expenses might be possible to reduce? Consider the flexibility you have or don’t have with categories like dining out, entertainment, travel, transportation, home mortgage or rental costs. And don’t forget about one time expenses like home remodels and upgrades. Obviously there is going to be a floor on the amount you can reduce your expenses so you need to be realistic about what works for you.
• Income: What can you do to earn more income and will it involve substantial sacrifice or will it be in something you already love doing? Will you try to get promoted or change jobs primarily so you can earn more money (whether or not you’re excited about the new role) and invest it in your future? Will you be willing to work nights and weekends or have additional irregular “gig” work?

Crunching Your Numbers

Finding your ‘Whys’, ‘Whats’, and ‘Balance’ are great mental exercises. But if you want to go beyond dreaming, you have to develop a willingness to crunch your numbers to truly understand what it will take to get where you want to go.

This isn’t a once and done exercise. If we assume it’s going to take you more than a year or two to reach financial independence, it’s likely that your goals may shift or you may discover new and interesting ways of reaching these goals. The possibilities are endless and they will be specific to you. But it may be helpful to crunch some numbers by creating different scenarios with alterations to these categories:

• Timing: When do you want to reach financial independence?
• Income: What are your different possible sources of income and will it all be passive income or a mix of passive and actively earned?
• Expenses: Where are the greatest areas of flexibility within your expenses?
• Investment Growth: How has your investment performance (in stocks or index funds, real estate, a side business you’ve started), changed your outlook for any of the other three categories mentioned above?

Significant changes to any one of these categories can have major implications for the others. And this is why cultivating a willingness to play around with the numbers based on different scenarios can be so helpful. When you’re ready, review the content in the “Long-term Savings” category (logged in users only) of this tier to see some precise methods for crunching your numbers.

Summary

Reaching financial independence is the overarching goal of this tier of financial maturity. Additionally you’ll also get the chance to consider your emergency fund one last time, what makes sense for you when it comes to paying off low-interest debt, additional insurance you may need, and protecting your assets through vehicles like wills and trusts.

Don’t Pass on Passive Income

If you want to achieve financial independence more quickly, it’s important to understand the types of passive income and how they differ.

Passivity in Passive Income Types

Let’s start by looking at different types of passive income broken down by the level of “passivity” that income source is defined by. 

	Passivity	Description	Examples
1	Completely Passive	After initial setup or qualification, this income comes in at a set time for a set amount like clockwork.	Social Security, employer pension
2	Diminishing Passive	These assets may provide completely passive income but the returns may diminish over time.	Royalties from creative work (writing, film, music etc.)
3	Maintenance Passive	This income is generated from an asset that largely “runs itself.” However it may require updating, upkeep, or hiring external people to keep it vibrant and relevant.	Rental property, e-Learning courses, subscription services, any business run mostly with hired labor
4	Flexible “Passive”	This income may not be passive but is so flexible that doing it doesn’t impinge on your desired lifestyle. The work can often be picked-up or dropped as desired.	Contract work, gig work (rideshare, food delivery, performance or speaking engagements), remote/online work  (transcription services, copy editing etc.)
5	Invigorating “Passive”	This income may be the least “passive” but because the work is so invigorating for you, it hardly feels like work and you expect to be able to continue it in your “retirement” years.	Hobby for income (woodworking, art for sale), some form of teaching, coaching, or mentorship

Passive Income Benefits

From a purely financial perspective consider the two major benefits to having passive (or partially passive) retirement income.

• Smaller Nest Egg: Reliable, passive income can be subtracted from the total amount of income your nest egg needs to directly generate. This allows you to retire with a smaller nest egg. In fact, you may realize that with a little passive income you are much closer to reaching financial independence than you realized.
• More Flexible Use of Nest Egg Assets: Passive income can give you increased flexibility in determining when you sell your invested assets. Put differently, if your passive income is large enough to support you in a pinch, you don’t have to sell your investments in a down year when they are worth less. Instead you can wait until the market is up and your assets have appreciated.

Actions

Write down the types of passive retirement income streams that are of interest to you. Then, consider the physical and mental skill sets and time commitments needed. Remember, you want to ensure that regardless of the level of passivity, the income is as reliable as you need it to be.

If you are self-employed, consider ways that you could train and hire others to perform the work for your business. If your business has a recognized brand, equipment, technology, methodology, or customer base, there are likely to be people who would like to leverage those assets. You may hire them directly or license a part of your business to them. 

Finally, do additional research on passive income by finding additional articles or books describing ways to generate passive income. You may be able to leverage the assets or skill sets you already have or learn about a few skillsets you need to gain additional expertise. Either way, once you’ve honed in on a few promising opportunities, write those down and try them out!