Do you need life insurance? Breaking Bad edition.
Bravo, Vince.
Breaking Bad is a five-season saga in which a determined man seeks an unorthodox type of life insurance for his family. The season 2 premiere features Walter White adding up his family’s long-term financial needs, and concluding that he needs $737,000 before he dies of cancer. Many people have joked that Breaking Bad couldn’t exist outside the US because of our very special health care system. But in this episode, Vince Gilligan was hinting that the root of all Walter’s problems was his failure to purchase a life insurance policy. Walter could have died at peace, and the good people of Albuquerque would still be calling Saul to this day.
How much life insurance did Walter White need? We’re here to answer that pressing question.
Why buy life insurance?
Insurance is all about risk transfer. You periodically pay an insurance company for coverage, and the payments are called premiums. In exchange for the premiums, they insure you against a financial risk — premature death in this case.1
The insurance company’s business model depends on building a large risk pool: most people who buy life insurance don’t die while covered. Premiums from the lucky survivors fund large payouts to the minority of people who die while covered. The lifespan of any individual can’t be reliably predicted, but the distribution of lifespans in a large group is much more predictable. Insurance companies facilitate a nearly magical process that dilutes risk by spreading it across a pool of many participants.
The big payout when a life insurance policyholder dies is called a death benefit. If you were to die while covered, your policy’s beneficiaries would receive the death benefit. There are two sets of beneficiaries: primary and contingent. Your primary beneficiaries receive the death benefit by default. You can name one or multiple, and dictate the share of the total benefit paid to each. Contingent beneficiaries receive the benefit only if all your primary beneficiaries pre-deceased you (i.e., they were already dead at the time of your death).
A death benefit is commonly used to (a) replace money that you intended to earn, (b) pay for labor (like child care) that you intended to do yourself, or (c) free up the beneficiary from some amount of work so they can do that labor instead.
Death benefits are tax-exempt. So if a policy provides a million dollars of coverage, the beneficiary would actually receive a million dollars. But once they have the money and invest it, those investments are just as taxable as any others.
We’ll focus on term life insurance here, in contrast to permanent life insurance. Term life insurance is simple, less expensive, and more suitable for nearly everyone. The definition is in the name: you buy a term life insurance policy over some term — 10 years, 15 years, 30 years — during which the premiums you pay to the insurance company are locked in.
A term policy with fixed premiums and a fixed death benefit is called “level term life insurance”, which is one of the most common types of life insurance. Most people should only consider level term life insurance, but if you’re curious about other types you can check out the further resources.
Coverage varies but, in general, death due to an accident, natural causes, murder, or even suicide under some conditions would qualify for a payout.
The price of term life insurance is influenced by the size of the death benefit, the term, and the insurer’s prediction about your risk of dying over that term. All else equal, being younger and healthier gets you a less expensive policy. If you smoke tobacco or have dangerous hobbies like hang gliding, your policy will cost more (or may not cover death due to certain high-risk activities).
You may be able to buy another life insurance policy after the term ends, but the pricing would increase because you’d be older and possibly less healthy. A new policy might be too expensive, or you could even become uninsurable if you develop a serious medical condition.2 So most people should buy a policy that lasts as long as they expect to need life insurance. That may be until age 60-65, when they’re approaching the end of their working years, but it depends on various factors that we’ll discuss below. If you need a term longer than 30 years, some companies sell policies with terms of 35 and 40 years.
Unless you already have enough money to provide for the people who depend (or will depend) on you, you should consider if and when you’ll need life insurance. Even if Walter White had received free cancer treatment, his family would’ve struggled after his death because his future income wasn’t insured.
I have seen a lot of terrible ways to calculate a person’s life insurance need. Rules of thumb like multiplying your income by a certain number of years rest on awfully shaky assumptions. I won’t spend time rebutting them, but hopefully this post will help distinguish sense and nonsense. We’ll explore three ways of determining how much life insurance you should buy, depending on your goals. These three approaches aren’t exactly what you’d see elsewhere: in a more academic text, you’d see labels like the “human-life value approach”. This is just how I think about it. We’ll start with the most ambitious and expensive approach.
1. Replace future earnings and unpaid labor
Walter makes $43,700 as an extremely overqualified high school chemistry teacher. He sometimes works at a car wash to pick up extra money. Skyler, his wife, hasn’t had a job since their teenage son was born, although she does flip items on eBay.3 Their finances are strained: they can’t even comfortably buy a new water heater. So if one of them were to die without life insurance, they would be in a desperate situation.
A life insurance policy for Walter would mainly replace his income. He does some work around the house, but the value of that work is small compared to his income.
At a first pass, you might think that Skyler doesn’t need life insurance because she has no income. But her labor has a high replacement value: taking care of the house and their two kids, including a baby, would cost a lot of money to hire out. If Skyler died, Walt would need to pay for child care. He would also need to quit his job at the car wash to be home at normal hours for his kids. So his income would fall, his expenses would rise, and he would do more unpaid labor.
Let’s walk through Walt’s situation shortly before he was diagnosed with terminal cancer at age 50 (after which it would be too late to buy life insurance). We’ll have to make assumptions. Your assumptions about your own future will be rough, but they’re a lot better than no assumptions and no insurance.
Walt plans to work for another 15 years until retiring at 65.
His pension and Social Security benefits would cover Skyler’s personal needs if he died after age 65.
His salary is $43,700 and will be raised by 2.5% each year.
He makes $8,000 annually from the car wash, and expects about the same rate of pay increases.
30% of his salary goes to tax and personal consumption, leaving 70% for his family.
The family’s share of earnings, 70% in this case, is an important estimation. As far as Skyler and the kids are concerned, they see only 70% of his gross salary while he’s alive. Income lost to tax isn’t relevant to anyone, and the money Walt spends strictly on himself isn’t relevant to life insurance. The family’s share is hard to estimate, but you can see why we want that fraction instead of Walt’s whole income.
We’ll assume that after spending some of the proceeds from the death benefit each year, the remainder would be invested with a 4% after-tax rate of return.
So how do we replace 15 years of continuous income with a tax-exempt lump sum? First let’s establish the qualitative relationships between what we know about Walt, and how much coverage he needs:
If his income or his expected income growth were higher, he would need to replace more income, so the required death benefit would increase. We’re assuming 2.5% annual growth.
If he planned to work longer than 15 years, he would need a larger benefit.
If we assumed greater investment returns on proceeds from the death benefit, the required benefit would decrease. We’re assuming 4% annual growth.
To keep this post at a reasonable length, we won’t calculate Walt’s life insurance need here. If you want, you can check out this companion post that fully explains the math. Here are the results under our assumptions:
If Walt lived: He would earn $927K before tax if he worked until age 65. The family’s share is 70%, which would be $649K. That falls short of the $737K he figured his family would need. If Walt never had cancer and worked until 65, his kids would likely have needed student loans.
If Walt died while covered: The death benefit would be paid in a lump sum, and the proceeds would grow due to being invested, so it’s naturally smaller than the income it’s replacing. To insure Walt’s future income, he needs about $491K in life insurance, so we would recommend a $500K policy with a term of 15 years.
2. Fund specific needs
Replacing all your future income can be overkill. Maybe no one in your life depends on all that money, and you want to insure a list of goals instead.
This is the Breaking Bad method. When Walter tallied up the money his family would need, he included college for two kids, the remaining balance on his mortgage, and basic expenses for ten years. In his case, the goals probably exceeded the income he would have earned, but that’s because his financial situation wasn’t very healthy.
The factors Walter considered are common: people generally think about providing for the largest items, like housing and college education. They may also want to provide for aging parents if they expect to support them financially or act as a caretaker.
You can ask yourself:
If I died tomorrow, how big would the gap be between the needs and goals I want to support, and how much money I have right now?
This approach can be more motivating because it connects directly to the people you want to support, instead of your own income. Not everyone keeps paying for their life insurance through the whole term, so motivation can be important!
To calculate a death benefit, we would use the same reasoning as we did above. In the companion post, we ran through an example of insuring college education for Walt and Skyler’s kids. We found that at the beginning of the show, they would need a death benefit of $223K to fully fund their kids’ college educations.
3. Temporary relief
What if, at the moment, no one depends on your future income or labor? There could still be a person (or multiple people) to whom you’d like to provide money in case of your unexpected death. This would give them a chance to take a break from life’s normal operations and grieve, without financial pressure that could obligate them to keep working.
How big should the death benefit be if temporary relief is your goal? There’s no objective calculation we can do here. To me, a reasonable guideline is one year of after-tax earnings for each beneficiary. If you followed that guideline, you would want to consider how their income might grow over the policy’s duration.
You can change your beneficiaries anytime. If you initially bought a policy with temporary relief in mind for your two close siblings, you could later get married and decide to make your spouse the primary beneficiary. Of course you should buy a policy with a particular goal in mind, but you’re free to change that goal later.
However, I don’t recommend collecting your life insurance in pieces, buying a small policy first with the intention of adding more later. The premiums charged for a $500K policy are less than double those for a $250K policy. If you start with a $250K policy and buy a second one later, you’ll likely pay higher premiums than with a single $500K policy. But if you need more coverage, that shouldn’t stop you from buying more.
Those are the three approaches! There are a few more important things to know.
How to use life insurance
Many employers provide group life insurance at no cost to employees. This is a nice benefit, but insurance through work shouldn’t be part of your long-term financial plan. It’s too ephemeral. Still, please make sure you promptly name a beneficiary when starting a new job that provides life insurance. Or if you’ve had a job for a while, are you sure you named a beneficiary? Many employers don’t remind you — it’s so easy to forget!
To decide on your own life insurance need with one of the methods above, you could follow the math in the companion post, or develop a plan with a financial advisor. If you’re considering an advisor, it’s best to avoid someone with glaring conflicts of interest. The person who provides advice about the main aspects of your policy — the type of policy, the term, the death benefit — should be separate from the person who sells you the policy. I recommend using a fee-only financial advisor, not someone with a commission-based incentive structure which encourages them to sell you more expensive products.
Many people can leave their death benefit to a responsible adult who they broadly trust to use the money as intended. Some people have more difficult situations. If you’re a single parent, for example, and you’d like to buy life insurance for the benefit of your minor children, you can meet with an estate planning attorney to develop a plan for them.
When should you buy an individual policy? As we discussed above, most people buy life insurance because someone relies on a combination of their future income and unpaid labor. If that’s in your future, you can start contemplating the details. If that’s already been true for years, you can accept your good fortune that you didn’t need life insurance so far, and start requesting quotes from the major insurance companies.
Let’s say a 33-year-old couple is preparing to get married and have kids. They decide to each buy life insurance and name the other as the sole primary beneficiary. They can buy a 30-year policy, pay a premium once a year, and protect their family in case of the worst. At age 63, that policy will no longer cover them. If they’ve navigated their financial lives wisely, there will no longer be any need to insure their adult children or their spouse, who can now rely on decades of savings and investments.
This is why most people’s life insurance shouldn’t be permanent: they can safely stop paying for it once they have little or no future earnings to insure. But you might notice an odd feature in this process. The family’s wealth gradually builds as the couple ages from their 30s to their 60s. As their remaining working years count down, their total future earnings naturally approach zero. From any perspective, their need for life insurance is progressively shrinking. Yet their coverage is constant for 30 years.
Let’s say this couple decided to buy $1 million of coverage per person. They could buy a single policy with a 30-year term, and carry the same protection over the whole period. But they don’t need a million-dollar policy the whole time! They could save money through laddering: buying multiple policies with different terms and death benefits. Reducing their coverage over time would more closely match their life insurance need. They could buy:
A $200K policy for 10 years
A $300K policy for 20 years
A $250K policy for 25 years
A $250K policy for 30 years
These would stack to provide coverage of:
$1M in years 1-10
$800K in years 11-20
$500K in years 21-25
$250K in years 26-30
This strategy reflects that wealth accumulation tends to happen slowly at first, then more quickly later in life. It also minimizes unnecessary coverage during the most expensive years to insure: those latest in life when you’re more likely to die. (Our recommendation for Walter White could’ve reduced his coverage after the first ten years, which would save him money.)
However, a $1M policy for 30 years is not four times the price of a $250K policy. As a general guideline, you can expect doubling your coverage to increase the premiums by 50-80%. You won’t know the precise differences until you get personalized quotes, which is why you should compare quotes for different policies you’re considering. Shop for quotes from multiple companies to ensure you get competitive pricing. Then you can decide if the discount for laddering is worth it to you, or if you want to buy a single policy.
After buying a life insurance policy, you should not only inform your beneficiaries about the policy, you should discuss how the proceeds would be invested. A written plan is much more solid than a purely verbal conversation that might be forgotten by the time it’s needed. This is one reason why there shouldn’t be a spouse who manages investments and another who ignores the issue. If the money manager dies, the other spouse might receive a huge windfall from life insurance, but that doesn’t insure them against bad decisions.
Life insurance is not a domain that rewards procrastination. If you know you’ll need it soon, it’s too late to buy it. You can start the process right now.
See you next week.
Further resources
Every Money IRL post is organized in The Omni-Post, and all vocab terms are here.
The Policygenius life insurance price index gives you a window into how age and death benefit affect premiums. Also see this brief post which explains that you save money by paying annual (rather than monthly) premiums.
For more info on term life insurance and how it compares to permanent life insurance, see this video by Two Cents and a number of good posts by the White Coat Investor. I linked to the excellent post on policy laddering above, and they have an overview of term life insurance with more details than I provided. You can see additional WCI posts on that topic by clicking on “Category: Permanent Life Insurance” or “Term Life Insurance” near the top.
Life insurance is one part of estate planning. We have an introductory post called “The easy parts of estate planning”.
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You can also think of life insurance as insuring your human capital. Your human capital is measured by your potential to earn money in the future. More specifically, it’s the present value of all the wages you expect to earn in the remainder of your working years. As you work, you convert human capital into financial capital. If you die before retirement, your human capital plummets to zero. Life insurance protects your loved ones against this possibility, whereas disability insurance protects against partial blows to your human capital while you’re still alive.
Some policies are guaranteed renewable at the end of the term, with a maximum price for the premium if the insured chooses to renew. Although this is a valid Plan B if you need life insurance for longer than you planned, I wouldn’t suggest it as Plan A.
Many term life insurance policies are convertible to a permanent policy during part of the term (e.g., the first 10 years of a 20-year term policy). If you find yourself uninsurable due to a critical health condition and you unexpectedly need life insurance beyond the term of your current policy and you have a convertible term policy and you aren’t guaranteed a renewal at the end of your term at a reasonable price, that is one of the rare situations in which I might suggest using permanent life insurance by converting your term policy.
She gets her old job back in S2:E7.
This was an especially interesting take on a usually dry topic!!!