If you’re considering the purchase of a residential or commercial investment property but need help crunching the numbers to determine if the investment makes sense, my free Rental Property Investment Analysis Calculator (using Microsoft Excel) may be just the investment analysis tool you’re looking for!

As you may or may not know, rental properties generate value for their owners in three distinct ways: Cash Flow, Repaid Mortgage Principle, and Property Value Appreciation.  Here’s a closer look at each of these profit sources:

Cash Flow:

Cash flow is the rent money left over at the end of each month after the property’s mortgage, taxes, maintenance, insurance and property management costs are paid. Obviously, your goal is to have more rent money coming in each month than you’re paying out in expenses; this is known as having positive cash flow. If the rent collected each month does not fully cover the monthly expenses of owning the rental property, you have a negative cash flow. While positive cash flow is best, there are some instances when it may make sense to have a negative cash flow (especially for the first few years) on an investment property, but we’ll get to that a little later.

Mortgage Principle Repayment:

If you’ve mortgaged a rental property and you’re using the rent money to pay the monthly mortgage payments, you are also reaping the benefits of having someone else pay down your mortgage.

Property Value Appreciation:

The third way investors make money with rental properties is through the property’s appreciation in value. In “real terms” the increase in a rental property’s value can be affected by inflation. If inflation is 3% per year and your rental property appreciates in value at only 2% per year, you’re rental property is actually decreasing in value in terms of “today’s dollars”.

Understanding these values and how to calculate them can be very difficult for beginner or aspiring real estate investors. Making this process even more difficult are the many variables that come into play that can affect some if not all of the ways you can make money with rental properties.

Variables that Affect the Profit of Rental Properties:

Purchase Price:

The biggest factor affecting the potential profit of a rental property is the purchase price of the property. All other things being equal, the more you pay for a rental property, the less your profits will be.

Down Payment:

Believe it or not, the less money you put down on a rental property, the higher your return on investment will be. This is because your return on investment is measured by how much money you actually personally invest into the property. If you put $25,000 down on a rental property and pay the mortgage off with rent money paid by the property’s tenant(s), the $25,000 is considered your investment. The total profit earned on the property from cash flow, mortgage principle repayment and the property value appreciation all result from your initial $25,000 investment that helped you secure a mortgage on the property.

Mortgage Interest Rates:

Mortgage interest rates will affect the profitability of rental properties. The higher the interest rate, the higher your monthly mortgage payments will be. Higher interest rates will also affect how much of the mortgage’s principle is repaid each month.

Mortgage Length:

Deciding how long to mortgage rental property can be a very hard decision; however, it is possible to determine the optimum number of years to finance a rental property to maximize the return on your investment (your down payment). The longer you mortgage the rental property, the higher your monthly cash flow will be (lower monthly expenses). On the other hand, the principle is paid down more slowly on the property. Using my rental property analysis tool, you’ll be able to find the “sweet spot” between these two variables to determine how long your mortgage should be on your rental property.

Property Value Appreciation:

Most properties will appreciate in value over the long term. Historically, homes in the United States have appreciated in value by about 4% per year (staying slightly ahead of inflation). The higher the annual appreciate rate (which you can only estimate), the more profit you will make on the rental property since you’ll be able to sell it (or charge more rent) than you could when you first bought the property.

Property Tax Rate:

The higher your annual property tax rate, the lower your monthly cash flow will be.

Maintenance Expense:

Another cash flow killer is maintenance expense. Many real estate investors count on spending 1% of the property’s market value each year in maintenance costs. For a $120,000 rental property, they’ll budgeting $1200 per year ($100/month) on maintenance costs.

Monthly Rent:

The more rent you can earn off a property, the higher your monthly cash flow will be.

Occupancy Rate:

You won’t be able to rent the property out 100% of the time. Once a tenant moves out, it takes time to ready the property and find a new tenant. There are also instances when a tenant is unable (or unwilling) to pay rent. Some real estate investors I’ve talked with say their occupancy rate is around 90-93% on average.

Property Management:

If you’re relatively new to rental properties or you live far away from the rental property that you own, you may considering using a property manager to deal with the tenants and handle any issues that may arise. If this is the case, you can expect to pay a fee of 5% to 10% of the monthly rent for this service. This fee will hurt your monthly cash flow.

Annual Insurance Premiums:

Depending on which part of the country you live in, you may pay anywhere between .3% and 3% of the rental property’s market value in rental insurance each year. Dividing this out over a 12 month period will allow you to determine the affect property insurance has on your monthly cash flow.

Inflation Rate:

Inflation can take a bite out of your cash flow as well as the rate at which your property appreciates in value when looked at in “real terms” or “today’s dollars”. As we discussed above, a home can appreciate by 4% each year, but if inflation is 2% the real value of the home’s appreciation is much less.

As you can see, any one of the above variables could adversely affect the profitability of a rental property. To help me analyze a particular rental property I’ve put together an easy to use Excel Spreadsheet that takes each of these variables into consideration and tracks their effect.

This rental property investment calculator is an experiment and I make no guarantee of its accuracy, but for me it is a valuable investment analysis tool. When I see a prospective rental property for sale, I can just plug the numbers into my investment property program and I will get a pretty good idea if the property is a good investment or not.

Entering the Rental Property Variables into the Program:

click image to enlarge

The first section of the rental property investment program is where you enter in all the variables that affect the profitability of the rental property. Note: The “Amount Financed” value is calculated automatically for you:

Analysis Results Section:

Once you’ve entered and reviewed all the relevant data into the spreadsheet, you can look at the “Analysis Results” section to get a sense of the profitability of the investment property. Below is a screen shot of what the results will be based on the sample data entered in the section above:

click image to enlarge

Let’s take a look at each of these values as I try to explain my methodology on how to calculate each one.

Total cash flow during the full term of mortgage’s repayment (or the length of time you plan to own the property): This value, $20,867.55, is the estimated total of all the monthly cash flow you will have over the term of the mortgage (or time you expect to own the home). It is calculated by adding the balances of each month’s rent-expenses. Even if the first few years are negative, as they are in this example, you still may end up with a positive overall cash flow because you’ll be able to charge more rent (theoretically) as the property increases in value.

Total cash flow during the full term of mortgage’s repayment (or the length of time you plan to own the property) in “Today’s Dollars”: This value, $17,488.58, is the estimated total of all the monthly cash flow you will have over the term of the mortgage (or time you expect to own the home). It is calculated by adding the balances of each month’s rent-expenses. This time, however, the monthly cash flows are “discounted” based on the rate of inflation you entered in the fields above. You can also see the comparison between the monthly cash flows and the “adjusted” monthly cash flows in the “Raw Data” section of the spreadsheet.

Monthly rent cash flow in “today’s dollars” after mortgage is paid off: After the mortgage is paid off (or if you pay cash for the property) your monthly cash flow will be much higher. The value of this monthly payment is displayed here and assumes the rent you can charge for the property increases at the same rate the property’s market value does.

Principle repaid during term of mortgage repayment in “Today’s Dollars” (will be zero if you paid cash for the property): This amount is equal to the amount you plan on mortgaging for the property. This is the amount of principle on the property that will be “paid off” by the renters.

Once the mortgage is paid off, this is the value of receiving your monthly rent payments in “Today’s Dollars” (assuming a conservatively invested perpetuity): One of the great things about owning a rental property is that after the mortgage is paid off you still have the monthly rent income coming in forever (providing you keep up on the property’s maintenance). The financial term for this sort of payment is called a “perpetuity”. You can calculate the present or current value of a perpetuity (the $825 monthly cash flow mentioned above), by dividing the value by a “conservative” interest rate. In other words pick an interest rate that you could be almost guaranteed to earn in the open market (I used 4% as a value in this spreadsheet). This value is “how much money” you would need to invest at 4% to earn $825 per month? Answer: $247,500. This value may not matter to some real estate investors, but it is an interesting value to me.

Increase in rental property’s market value in “Today’s Dollars” during the mortgage term (or during the time you expect to own the property): If the investment property appreciates in value at the same rate of inflation, this value will remain ”$0” because there will be no change in the “real” value of the property. However, if you enter a different inflation rate and property value appreciation rate the difference will be calculate here.

Compound Annual Growth Rate (Return on Investment) of your initial investment (down payment) during the time you plan to own or mortgage the home using the “geometric average” formula including the effect of inflation: This value (7.84% in our example) is the average return earned on your initial investment (which is considered to be your down payment). In other words, this is the effective rate that your investment would grow annually in order to achieve the “total profit” calculated in the next cell below.

Total profit during the mortgage repayment period (or during the time you expect to own the property) in “Today’s Dollars”: In the values above, the program has calculated the “profits” of the investment over the three main sources of value rental property investor receive (cash flow, principle repayment, and property appreciation). The value in this box is simply the sum of these three individual profit sources of owning a rental property. In our example, the total estimated profit of purchasing the property using a 15 year mortgage is $155,023.39 in today’s dollars.

Raw Data:

The “raw data” calculated by my experimental rental property analysis program also reveals some interesting data that is of interest to the beginning or aspiring investor. Here is a screen shot of the raw data section of the Excel Sheet:

click image to enlarge

Month by Month Cash Flow Analysis: Perhaps the most useful information found in the “raw data” files is a breakdown of the rental property’s monthly cash flows. As you can see in our example, the first few months start off cash flow negative (the property owner has to pay extra out-of-pocket cash to cover expenses). However, because of the appreciation in property value and rent, the cash flow for our example rental property turns positive by the 38th month (not shown in this screen shot).

Property Value Appreciation: You can also see the estimated monthly increase in the property’s value.

Increase in Rent: Because we’ve fixed the estimated monthly rent you can charge for the property, you can also the average monthly increases you’ll be able to charge for rent. The rent won’t actually increase each month as shown in our example because you’ll probably fix the rent in 12 month lease increments. For the purposes of our calculations, the effect of the increasing the rent monthly does not affect our overall calculations.

Let me know what you think!

This rental program investment program is far from perfect, but it is a good starting point for me as I consider investing in rental properties. As always, please be sure to consult a qualified investment professional before acting on any of the results calculated in this spreadsheet since I cannot guarantee their accuracy or validity.

If you have any ideas for improvements or see any mistakes that need to be corrected please email me or leave a message in the comment section below!

Good Luck!

P.S. I was inspired to write this article and create the Excel spreadsheet after reading posts on real estate investing by J Money, Lazy Man, 2Million, FMF and Flexo.  They really got me thinking about the benefits of investment properties and hopefully this rental property investment program will help them too!

On the advice of our USAA personal finance adviser, my wife and I decided to purchase private term life insurance outside of what we already had through my employer.

Note: USAA provides FREE personal financial advice for all members and it is an extremely valuable service if you have questions about investing, college savings, insurance, retirement, etc.).

After filling out an online application for term life insurance through USAA, we received a call from a USAA representative who asked a few additional questions about our respective applications and then transferred us to a third party medical company who asked us medical related questions such as whether or not we were smokers, previous medical conditions, current medications, etc.

Next, we had to arrange for a quick home visit from a nurse to measure our height and weight, take our blood pressure, and collect urine and blood samples that would be sent back to a lab for further analysis.

That was it! All told we each had about an hour invested in the entire application process including filling out paperwork, scheduling the at-home visit and enduring the actual physical examination.

Don’t let the burden of applying for term life insurance hold you back from protecting you and/or your family’s financial well being in the event something happens to you!

Once again a popular website has published a story about how much more money college graduates earn over their lifetimes than workers with only a high school diploma.

“The difference between a bachelor’s degree and a high school diploma is at least seven figures over a lifetime”, says Christina Couch from Bankrate.com in her article “The Million Dollar Difference of a College Degree“.

Using data from a Georgetown University study, Couch cited several examples where college graduates did “earn” substantially more than their non college educated counterparts. In fact, of the 5 distinct job categories that were profiled in the article, all of them earned at least 1.3 million more in lifetime salary.

Unfortunately, the article fails to consider the opportunity cost of the actual college education expense itself. Instead of paying $75,000 over four years for tuition, room and board, what if you decided not to go to college and went straight into the work force (as this article suggests is possible).

What would that $75,000 grow to over your working lifetime (starting at 18 years old and retiring at 65 = 47 working years) if you instead invested it in a mutual fund earning a realistic 7% return on investment.

A quick entry into Excel reveals this investment would grow to $1,803,428! In other words, you’d actually make $500,000 more over your lifetime by not going to college assuming you can gain employment in the jobs profiled without a college degree as Couch’s article does.

Things are not always as cut and dry as they seem!

As I mentioned in yesterday’s article comparing the tax advantages between 401K and Roth IRA plans, I’ve decided that it is better for me to max out my 401k first before starting to invest in a Roth IRA. The deciding factor for me is that I expect to be in a lower income tax “bracket” in retirement than I am now.

Money that I put in a Roth IRA today would be taxed at my current tax rate of 28%. No matter how optimistic my retirement saving’s projections are, I don’t expect to have the same income in retirement as I do now and “theoretically” any income I do have should be subjected to a lower tax rate.

So when does it make sense to fund a ROTH IRA?

Higher Tax Rate in Retirement: Obviously, if you feel you’ll be in a higher tax bracket when you retire, its better to pay taxes now with a Roth IRA or Roth 401K than it would be to pay higher taxes later through a tax deferred retirement plan like a 401K or 403B program.

Save More: Because the limits are the same for a Roth IRA and a Traditional IRA, you can effectively save a higher percentage of your current annual income for retirement each year because $5,000 in a Roth is worth much more than $5,000 in a Traditional IRA (remember you still have to pay taxes on funds in a Traditional IRA).

401K is Maxed: If you’ve already maxed out your 401K or similar retirement account (403B, etc.), Roth IRA’s are usually the “next best option”.

Investement Option Flexibility: If you don’t like the investment options in your current 401K and you want more flexibility, opening a Roth IRA (or Traditional IRA) will give you access to a virtually unlimited number of investment options.

Everyone’s financial situation is different. The ideas and opinions about ROTH IRAs and 401Ks above relate to my own specific financial situation and are intended to give you a broader perspective of what may (or may not) be best for your specific financial situation. If you have any doubts about whether a ROTH IRA or 401K is better for you (after you invest the minimum in your company’s 401K program to get their match) be sure to speak with a professional financial advisor (I’m just some dude with a blog).

I read a great article comparing 401ks and IRAs  at Cash Money Life the other day and I wanted to expand on one of its key elements:

Roth IRAs are non-deductible, which means you use post-tax money to fund your account. However, the distributions made during retirement age are tax exempt, which is the main reason people invest in a Roth IRA.

Are average investors really doing the right thing by investing in ROTH IRAs?

If your company matches your 401k contributions up to a certain percentage of your salary it makes sense to invest at least enough to get the full company match. The question is, should you contribute more to your 401K (above the matching percentage) or should you open a ROTH IRA and fully fund it before resuming contributions to your 401K?

If you listen to personal finance guru’s like Dave Ramsey and Suze Orman, they repeatedly tell you to invest enough to get your company’s 401k match, then max out a Roth IRA and only then (if there is any money left over) invest any additional money you can in your company’s 401K up to the maximum annual contribution limit (currently $17,000).

The theory is the money in the Roth IRA will grow “tax free” and you won’t have to pay taxes on it when you withdraw the money in retirement. The caveat is that you pay taxes on the money before you put it in the ROTH IRA.

On the flip side, money you put into a traditional 401K account is not taxed before it goes in the account and you receive the benefit of a lower tax bill now (instead of later in retirement). This drawback here, or course, is that you WILL pay taxes on 401K proceeds when you withdraw the money in retirement.

And so begs the inevitable question:

Is it better to Pay Taxes Now through a Roth IRA or Pay Taxes Later through a Traditional 401K Plan?

The truth is, if your tax rate remains the same now as it does in your retirement years, the “real” value of your retirement savings is EXACTLY the same.

Example: Lets say you have an extra $10,000 per year above what you’re putting in your 401K to get the company match. You plan on retiring in 30 years and you want to know if you should invest your money in a ROTH IRA or a Traditional 401K. Which option will save you the most money on taxes over time?

ROTH IRA Scenario:
You invest $10,000 per year in a ROTH IRA for 30 years assuming an average annual return of 8%, and a tax rate of 25%. Because of the 25% tax rate, you would actually only be contributing $7,500 per year (after tax dollars) into the ROTH IRA. After 30 years your retirement account would grow to $849,624.08.

Traditional 401K:
You invest $10,000 per year in a traditional 401K for 30 years assuming the same average annual return of 8% and a tax rate of 25%. Your account grows faster because you are contributing the full $10,000 each year (before tax) into the traditional 401K, the difference is you’ll be responsible for paying taxes on the money when you withdraw it. After 30 years your 401K retirement account would grow to $1,132,832.11.

All other things being equal, 25% tax on $1,132,832.11 leaves us with$849,624.08, the exact same amount you’d have if you invested the money in a ROTH IRA.

What Will Your Tax Rate Be in Retirement?

As you can see from our case study example, our decision to invest in a Roth IRA vs. a Traditional 401K really comes down to what you think your tax rate will be in retirement.

If you think your tax rate will be lower in retirement (like I do), it makes sense to invest your money before taxes are taken out in a retirement account like a Traditional 401K or Traditional IRA.

If you think your tax rate will be higher in retirement, it makes sense to invest your money in a ROTH IRA or “Roth 401K” if your company sponsors one.

The way I see it, if I’m making more money in retirement than I am working (putting me in a higher tax bracket), I’ve done some serious over-saving for retirement. That would mean in the few years leading up to retirement I could actually retire and make just as much money. That just doesn’t seem practical to me, especially considering my living expenses should be considerably lower in retirement (mortgage paid off, kids off on their own, etc.).

I fully respect and endorse the services offered by professional extermination companies like Orkin, Terminix, Ecolab and Modern Pest Services.   If you have a serious pest issue with your home (termites, bed-bugs, etc.) don’t take chances, hire a professional exterminator!

On the other hand, if you find an occasional spider or ant creeping around in your home, this is how I would get rid of them.

Every three months (4 times a year) it was the same old routine. The local exterminator would come to our house, spray some “stuff” around the perimeter of our yard, squeeze some stuff out of a “syringe” inside of our house, and sprinkle some “dust” in our basement. 20 minutes later the exterminator was on his way and we were sent a bill for $120.

After watching this process for a few years and paying thousands of dollars in pest control services, I decided it was time to try a do-it-yourself (DIY) approach to killing those annoying ants, spiders and Lyme disease carrying ticks.

Chemical Gel Professional Exterminators Use to Kill Ants:

While it is true you need a special license (permit) and training to buy “professional pesticides“, it turns out the main chemical my local exterminator used to kill carpenter ants can actually be very easily and legally purchased online through everyday sites like Amazon.

The “syringe” the exterminator was using was “Maxforce Carpenter Ant Bait Gel“. The gel was applied in various areas around our kitchen and bathrooms and other areas where the ants might get into the house (plumbing lines in the basement, doors, window areas, etc.).  The ants would take the bait and live long enough to bring the bait back to their nest where it would kill all of the ants too!

An alternative to this professional exterminator product is to simply mix BORAX with water and sugar. Drop this solution onto small pieces of cardboard (business cards work great) and place in the areas around your house were you’ve seen the ants!

For even more tips and suggestions for getting rid of ants, check out JD Roth’s advice from the personal finance blog Get Rich Slowly.

Chemical Spray Professional Exterminators Use to Kill Spiders Ants and Ticks:

Through my research, I also discovered that one of the most popular outdoor spray pesticides used by professional exterminators was “Demon WP” and it too can be purchased online without a license.

Demon WP is a crack and crevice and/or spot treatment for residual and contact control of ants, carpenter ants, cockroaches, crickets, spiders, and ants!  In other words, it kills insects that are sprayed by it and also kills insects that come in contact with the chemical after it has dried. It CAN be used outside your home and inside your home BUT YOU MUST READ THE DIRECTIONS CAREFULLY! If you have any doubts as to how to use the pesticides make sure you contact the manufacturer OR consider the services of a professional extermination company!

IMPORTANT: Make sure you read the manufacturers directions for use very carefully! Pesticides are not something to fool around with!

I’m looking forward to trying these products next year and sharing my results. I haven’t completely ruled out the possibility of hiring a professional pest control company in the future, but I’m going to give these two products a try first.  Share you own pest control DO IT Yourself success stories (and failures) below.

Borrowing money from your 401K is usually a very bad idea. This is especially true if you’re planning on using the money for something silly like buying a boat or going on a vacation. As my wife and I learned a few years back, it doesn’t take long for your debt to get out of control.

However, there are cases when it might actually be a good idea to borrow money from your 401K (buying real estate properties to rent out is not one of them).

If you remember back to last week’s personal finance case study, one of the recommendations I had for the young couple struggling with debt was to sell one of their expensive vehicles and get a less expensive car.

If you owe less on your vehicle than it is worth, you can easily sell the car, pay off the remaining balance of the loan and buy a less expensive vehicle. Even if you need to borrow a few thousand dollars to buy a less expensive car, it’s better than having a $20,000 loan hanging over your head for your current car.

But what if you owe more on your car than it is worth (negative equity)? If you owe more on your car than you can make selling it, the best option is to speak to the bank who owns the loan and ask them if they would allow you to borrow the difference between what you owe on the car and what it is worth (so you can sell the car). Unless you have a really strong credit rating (720+ FICO Scores) or have other assets to use as collateral, this is probably not an option.

Using your 401K balance as a tool: If you have money in your current employer’s 401K program, you may have the option of borrowing money from the account to use as you wish. When you borrow money from your 401K account, you pay the interest back to yourself (instead of a bank) which helps to sweeten the deal.

Lets say you owed $5,000 more on your current car than it is currently worth and your efforts to borrow the difference from your bank or local credit union have failed.  You could borrow $8000 from your 401k, sell your current car (paying the difference from your 401K loan proceeds) and buy an inexpensive yet reliable car for $3,000.  

Instead of owing the bank $20,000, now you owe yourself $8,000 and the interest you’re paying goes to you as well!  

The drawback of borrowing money from your 401K is that you have 60 days to pay the money back if you lose your job or you’ll be forced to pay income taxes and a 10% penalty on the outstanding balance of the 401K loan.

Another factor you need to consider is that funds borrowed from your 401k may not have the same protections from lawsuits and bankruptcy as funds that remain in your 401K.

“Borrowing money so you can borrow more money is a really stupid idea”…TFOM

Ever since I published my free commercial real estate investment calculator, I’ve been receiving emails from people asking if they should borrow money from their 401K to use as a down payment on a rental property or other commercial real estate.

As many aspiring real estate investors have discovered, getting your first rental property is often the most difficult because of the large down payment required by lenders. With very few liquid assets to use as collateral, some investors look at their 401k balances as a means for getting their foot in the door in the rental property business (literally).

Depending on your company’s 401K plan, you may be able to borrow money from your 401K to use as you wish. Many plans will allow you to borrow up to half of your 401K’s balance up to a maximum amount of $50,000 (each plan is different).

Disadvantages of Borrowing Money from Your 401K to Invest in a Rental Property:

Lawsuit Risk: When you remove money from your 401K retirement account you lose the protection those assets have from lawsuits, bankruptcy and other claims against your assets. The amount you borrowed will also not be protected from creditors in the event you file for bankruptcy. The legal protections that are extended to you by keeping the money in a 401K or other qualified retirement are one of the main reasons people don’t borrow from their 401K accounts to buy rental property.

Early Withdrawal Penalties: If you lose your job (or resign), you have 60 days to pay the 401K loan back or it will be considered an early withdrawal and you’ll be required to pay income tax on the remaining balance of the 401K loan plus a 10% early withdrawal fee.

Funding Source: Some lenders will not accept money borrowed from a 401K to be used as a down payment on rental or other types of commercial real estate properties.

Advantages of Borrowing Money From Your 401K to Invest in a Rental Property:

Easy Access: One advantage (many financial planners consider it a disadvantage) of borrowing money from your 401K loan is that you can have the money in your account in just a few short days.

Interest: Instead of paying interest back to the bank, when you repay your 401K loan you are paying yourself back the interest.

Possibility: If you have no other means of securing a down payment, the 401K loan option may be the ONLY way you’d be able to secure funding for a rental property.

Diversification: Borrowing money from your 401K to invest in real estate allows you to diversify your investment portfolio by reallocating some of your retirement funds from traditional mutual funds. With both mortgage interest rates and real estate prices at historic lows, many investors feel there is more opportunity for higher returns in rental properties vs. mutual funds and the stock market.

Borrowing money from your 401K is a viable option for securing mortgage down payment on a rental property but it doesn’t come without risk. Personally, I believe that borrowing money so you can borrow more money is a really stupid idea and I certainly wouldn’t consider doing it unless I had a substantial emergency fund built up to cover the myriad expenses that often come up when dealing with commercial real estate properties.

If you qualify, term life insurance is an excellent way to protect your family’s financial independence in the event of your death. However, before you sign a contract for term life insurance, here are some important things to consider.

Inflation:

Term life insurance offers a fixed payout to the policy holder’s beneficiaries in the event of his or her death. The “term” part of term life insurance refers to the length of time the policy is good for. Most term life insurance policies are available in 5 year increments from 5 years to 30 years (or more). If you purchase a fixed 20 year term life insurance policy for $500,000, you’ll pay the exact same premium each month throughout the “term” of the policy (20 years in our example).

If you die at any point during the 20 year policy, your beneficiaries will receive the face-value of the policy ($500,000). Now comes the “tricky” part…keep in mind that this “payout” is not adjusted for inflation. If you die 18 years from now (and you’ve maintained the policy) that $500,000 will not be worth the same amount as it would be today because of inflation.

If you consider inflation to be 3% per year, your $500,000 policy paid out 18 years from now would only be worth about $300,000 in today’s dollars.

Below is a chart I created that shows the declining value (in today’s dollars) of term life insurance at various rates of inflation:

Fixed Payments:

As mentioned above, your monthly payments are “fixed” with a term life insurance policy. This is good news because each year that goes by, your monthly premiums may actually seem “cheaper”. Not only is your income likely to grow as you get older, inflation will factor in and that $30 premium you’re paying today won’t seem nearly as expensive 5, 10 or 15 years from now.

It may be worth it to purchase a larger life insurance policy now to lock in a low rate to protect any salary increases you may have in the future.   Additionally, locking in to a term life insurance policy now will protect you in the future should you be diagnosed with a medical condition that may prevent you from qualifying for term life insurance at the best rates.

Future Financial Needs:

If you’re 40 years old, have two kids in high school and the mortgage is less than 10 years from being paid off, you may not need a 30 year term life insurance policy. Not only will the rates be expensive (becomes someone is more likely to die between 40 and 70 than they are between 40 and 60), you simply won’t need to have a large life insurance policy “hanging over your head” once your kids are out on their own and the mortgage is paid off. Realistically, a 15 or 20 year term life insurance policy may make better financial sense unless your partner or someone else still depends on your income to maintain their standard of living .

A better options may be to opt for a 20 year term life insurance policy and deposit the difference in premiums into a retirement or other savings account (or use it to pay off debt).