How Much Life Insurance Do I Need?
The sole purpose of life insurance is to protect your dependents from financial hardship in the event of your death. The amount of cover should be enough to allow your dependents to be free of financial burden up until the time they would no longer require your help.
There are number of other factors to consider when determining the amount of coverage. Salespersons provide short and sweet answers like multiplying your income or simply taking care of your current debts. These answers are easy, but usually inaccurate. Working out the true amount of life insurance you need does take time and some homework, but certainly worthwhile.
How much life insurance do I need? – the short answer
Without consideration to any other circumstances or your individual needs, financial planners normally advise to cover your salary for five to seven years. This estimate will increase to around 10 years replacement salary if you have significant debt, such as a mortgage on your home, or if you have dependent children.
For example, if you make $50,000 per annum, a salesperson would normally recommend cover between $250,000 (5 years’ salary) and $500,000 (10 years’ salary).
How much life insurance do I need? – the accurate answer
To obtain a precise amount, you will need to look at your own individual circumstances, beyond just your age, income and health. You need to consider how much your spouse and dependents would need to live on in the event of your death. That is the vital question.
Don’t just look at how much income will be lost. That income may be too little or too much to cover what your dependents actually need.
Experts recommend this formula to ascertain your life insurance amount:
Current needs + long term needs – resources = how much life insurance I need
You may wish to write down a checklist for the expenses and income that follow.
Current & Long Term Needs
Work out your annual expenses. You should account for any expenses that will enable your partner and/or your dependent children to live comfortably in their current lifestyle, including:
- Your surviving partner’s annual living expenses
- Your children’s annual living expenses
- Child Care (with just one parent, your children may need additional child care. Estimate the additional cost based on your current rates).
- Education (look into the average cost for either private college or public schooling; consider if your children would qualify for financial aid).
- Funeral & estate costs (obtain quotes for funeral costs and cemetery charges. Average funerals can cost upwards of $7,000. Your attorney can give you a price for settlement costs, depending on the complexity and extent of your estate).
- Debts – list any debts that would require immediate payment.
- Mortgage – this should be included in your partner’s living expenses as a periodic payment, unless you have mortgage insurance.
- Contingency – usually an additional 3 months contingency is recommended. You can also provide for some extra funding for your spouse or children to live more comfortably, rather than just covering day to day living expenses.
Multiply each expense by the number of years it will be needed. Remember to account for inflation. The total amount resembles what your spouse and/or dependents need in the short and long term.
Resources:
Offset the expense total against the total income you would still have after your death, including your spouse’s after-tax income, any interest being earned on your savings and social security benefits. For an estimate of your social security benefits call 800-722-1213.
By deducting the total income from the total expenses, you will arrive at your optimum insurance amount. If you already have a policy, you may need to top up or you might even be over-insured.
Life insurance to cover children
Whether you’re the breadwinner or the stay at home mom or dad, every parent should have life insurance for their children. It’s especially important for the working parent to be insured. Clearly the surviving spouse will struggle. They will need to seek work, which may be difficult depending on the length of time they have been out of the workforce. Most likely, the survivor will need to arrange childcare whilst struggling to pay rent or mortgage payments and all accompanying bills.
Just because you’re a stay at home parent and don’t bring in any income doesn’t mean your time is not valuable. You need insurance to compensate for your time. How will the surviving earner take care of the children, maintain the home and keep up with work? You need to accommodate for childcare expenses and perhaps even household maintenance expenses depending on the breadwinner’s work commitments.
How much is enough? There are a number of factors which you should consider when buying life insurance to protect your children. If you’re a couple, you need to consider whether the surviving partner will need to pay for child care. You may both be able to cope with minding the children now, but it won’t be as easy if there’s just one of you.
If both parents are earning, falling on one salary will cause a huge financial burden which will impact on the surviving spouse and the children. You should think about your child’s educational and health needs, for now and into the future.
Single parents should especially buy life insurance to protect their children. You need to have proper arrangements in place. Will the children go to an ex-spouse, to another family member or a close friend? The amount should be sufficient to enable the person to support your children including their educational and health needs.
Does your employer provide health insurance for the family? If not, or if only one of your employers does, you will need to consider additional health related costs.
Another factor is your child’s age. Will they be old enough to support themselves soon? If they’re only young, you will need to increase your insurance cover, since they would have been dependent on you for longer.
Life insurance and your debts
If you have dependents, don’t just buy insurance to cover your debts. This method fails to take account of your children’s and your spouse’s living costs and other expenses such as health, childcare and education.
When calculating your liabilities, don’t just look at your present debts. A large mortgage will require more amount of cover. If you pass away, how are your dependents going to pay mortgage repayments? Will your partner cope with paying off the mortgage themselves? You need to look at your immediate and long term debts. You want to make sure that if you pass away, your partner and your children can live in the family home without being evicted by the bank.
What about investing?
Remember, the whole purpose of buying life insurance is to protect those who are financially dependent on you. Don’t buy whole life insurance with less coverage in the hope the investment component will earn enough to cover your dependents when the time arrives. Not only are these policies more expensive, you may end up being underinsured. You should always be covered for the necessary amount, not in the future, but right now. Life insurance is not an investment, its protection.
Once you’ve calculated the total amount required, you may realize that you can’t afford the premiums for that amount. If this happens, don’t scrap the idea of getting covered. Look back at your expenses checklist and see if there’s any your dependents can do without. Only leave costs that are absolutely necessary. Remember, you should reassess your needs at least every three years or earlier if you undergo a life changing event such as having a baby.