Debts are gone? You probably don’t need a life insurance life line. Photo by Megan Menegay on Unsplash
I can’t count the number of conversations I’ve had in recent months with clients, family members, or friends who are adamant about paying off their mortgage as soon as possible. These aren’t just pre-retirees wanting to eliminate debt before retirement either. In many cases it’s Gen X clients or even Millennials who just want it gone.
I think there are some important reasons for this.
First, as one person recently put it, debt can feel like a “ball and chain,” even if the monthly payments are comfortably afforded. As home prices have increased in value, many recent homeowners have mortgages well into the six figures looming over their heads.
Second, there’s a psychological factor when one considers no longer having a monthly mortgage payment to make. The recommended proportion of one’s monthly spending going toward housing expenses is 30%. So for someone earning $5,000 per month, they shouldn’t be spending no more than $1,500 per month on their mortgage, property taxes, and homeowners insurance. Obviously then, as soon as that mortgage is paid off, the lion’s share of that $1,500 payment is gone, creating a big stream of discretionary cash flow for that individual or family.
But there are other ancillary savings that come when a mortgage is paid off. One of these, in my view, is life insurance costs.
The primary purpose of insurance is to protect wealth, either human earning potential or investment assets. For example, life insurance is so crucial for a young family because there is tremendous earning potential of one or each spouse, and the financial needs of the children, if they have them, are high as well. The family will have shelter, food, education, and medical needs, among many others over their lifetime. Life insurance is an ideal way to ensure those needs are provided for.
But what if their mortgage is paid off as well as all other debts? The calculus changes. Some life insurance may still be needed, but it’s likely much less.
Let’s take it a step further. What if the mortgage and all other debts are paid off, and the kids are out of the house? Is life insurance still needed? If so, the required amount is even lower still.
Finally, consider if all debts are paid off, the kids are out of the house, and the couple is prepared to retire, living on their Social Security and retirement nest egg. What role does life insurance play then? I would argue that, by definition, life insurance no longer has a role, since its purpose is to protect human earning potential (no longer needed) and investment capital (sufficiently accumulated).
I see too many pre-retirees heading toward retirement with costly life insurance policies. In some cases it may be important to keep these policies in place, for the two reasons I mentioned. But in most cases they aren’t necessary, especially when all liabilities have been paid off.
I wonder if over time I will hear from more and more people about their aversion to carrying a large mortgage, especially if/when interest rates begin to rise. If rates do rise, I suspect I’ll be having even more conversations about paying off one’s mortgage early. Doing so can create a significant increase in discretionary cash flow, and allow many to lower or even eliminate life insurance.
Editor’s Note: There may be some reasons to hold on to a life insurance policy even if debts are fully paid off and no new substantial debts are expected to be incurred, such as holding onto a life insurance policy with cash value for end-of-life funeral expenses, estate planning purposes, and/or a policy with a steep surrender charge; however, I feel these instances are more the exception than the rule.