Should you buy life insurance or be self-insured?

Should you buy life insurance or be self-insured?

Updated March 9, 2018: Life insurance is invaluable when it comes to protecting your family financially. It ensures that if the worst were to happen, your family can continue without your income.

It provides great peace of mind. But to some people, that’s all it offers: peace of mind. If you don’t die, that’s great for obvious reasons, but you paid a lot of money just to feel good.

What if you could have that same peace of mind without having to pay for the life insurance policy?

That’s where the concept of being self-insured comes in. It’s being able to cover everything you need, but without an insurance policy in place. But is it really possible? And if it is, how can you get to that point in your life?

What does it mean to be self-insured?

So what does it really mean to be self-insured? Let’s take a look at the varying stages of the insured spectrum:

  • Paid insurance coverage – This is where most people are. We can’t afford to buy a completely new car if it gets totaled, we can’t just go buy another house if a fire breaks out in our home, and we can’t make sure every expense is covered for our family if we die. Instead, we pay a little bit each month or year with the understanding that we’ll be paid out in the event that we need the money.

  • Partial self-insurance – Some insurance, like health and auto, are required by law. Some people might buy the minimum amount of coverage needed to not be in violation of the law, but that’s it. They’ll have, say, a low-premium, high-deductible health plan, paying a small amount upfront each month but having the financial ability to cover a high deductible. In other words, if you’re at this point you’re still buying insurance, but just the bare minimum and handling the rest yourself

  • Complete self-insurance – The dream situation: You and your family can cover all of your expenses and financial needs, even in unexpected scenarios outside of your budget. Sure, you may still need some insurance, like the aforementioned auto and health insurance, but those are formalities. If you were to die, your family would be fine, financially-speaking. If your house was destroyed, you’d simply be in the market for a new one.

Having total financial independence sounds nice. But it can be harder to get there than you think without a little help.

How do you know if you can be self-insured?

"That sounds great!" you say. "I want my family to be taken care of but I don’t want to pay for life insurance. Self-insurance it is!"

But first you need to figure out if you can actually afford to be self-insured. Here’s an easy formula to figure it out:

Amount you need = Amount you have

See? Easy.

Take the amount of money your family will need to cover any expenses – whether it’s immediate cost of living expenses, long-term plans like paying off a mortgage, one-time big expenses like college tuition, and/or funding your partner’s retirement – and that’s the amount that you’ll need to have on hand to be self-insured.
And the amount you have is...well, the amount you currently have.

Keep in mind that this isn’t the total of all your assets – your house might be worth $600,000 but you don’t really want your family to have to sell it, since that sort of defeats the purpose of providing them with financial protection – but liquid assets that can be easily used.

If that seems like it’s expensive, that’s because it is. If you still owe $250,000 on your house, and you’re going to need to pay $30,000 for each of your two kids to go to college, and you were planning to have $1,000,000 saved for retirement, and that’s not even taking into account what you’d need to buy food and clothes and...yeah, it adds up quickly.

That’s why the easiest path to being self-insured is through an unexpected source: Term life insurance.

I know, buying life insurance to be self-insured seems like an oxymoron. But the truth is, no one will be instantly self-insured. Your expenses will probably look like a bell curve over time. When you’re young, you don’t have a lot of things that you need to cover. As you buy a home and have kids, your expenses rise. Then, once the kids are out of the house and you’ve paid off your mortgage, your expenses go back down.

That’s why term life insurance is perfect. It gets 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.

If you add term life insurance to your self-insurance equation, it looks like this:

Amount you need = Amount you have + life insurance coverage needed

As you get older, the amount you need will decrease, the amount you have will increase, and your life insurance coverage will be there to make up the difference, as a safety net.

Then, when your term life insurance expires, the amount you have will ideally meet or exceed the amount you need. When you’re able to self-insure, you’re not wasting money on a life insurance policy that’s become unnecessary.

Now the question is how you get the amount you need high enough to meet your expenses.

This is where insurance meets investing. In order for the amount you have to be enough for you to self-insure, it’ll have to grow. In order to do that, you need to manage your money wisely over the years:

  1. 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 nothing to work with when your term life insurance policy expires. A simple spreadsheet or a number of apps can help you build a budget that fits your lifestyle and still leaves a little left over.

  2. 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. And 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. 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.