You have decided that it is time to take out life insurance. You know why do you need this. There is one more obstacle; you ask yourself, “How much life insurance do I need?”
This can be more difficult than figuring out how much health or auto insurance you need. You must have them and each has the minimum coverage you need.
With life insurance, you are not required to have one, and there is no minimum amount you must have. So, if you are unsure about your life insurance needs, this guide will help you decide how much coverage you need and the different ways to calculate your needs without overpaying.
We want to help you save money and also ensure that your loved ones don’t end up in dire financial straits.
“Death is one of the few things that can be done just as easily while lying down.” – Woody Allen
Let’s say you know the difference between term insurance and life insurance. Do not worry; we are not going to go into details related to monetary value or variable life insurance products.
Hopefully by the time you finish reading this, you will have a clear idea of how much life insurance you need. Then you can overcome this obstacle and find the most appropriate policy for your needs.
Why life insurance?
First, why is it called life insurance? We probably can’t call it death insurance because people don’t like talking about death.
Plus, can you picture yourself as a life insurance agent trying to sell death insurance? Most people will avoid you even more. Calling it life insurance is not so gloomy and scary.
So, let’s talk about your death!
Life insurance is important. You need it if you love or owe someone.
Families in need of life insurance have insufficient funds. According to the Life Insurance Association and Market Research, “Fewer than half of the average consumers between the ages of 25 and 64 have individual life insurance policies.”
Even more striking, those who own life insurance policies average $ 167,000 in coverage. If you subtract the funeral expenses and medical bills, this replaces only two to three years of disposable income for most families. Ouch!
So how much life insurance do I really need?
Once you have decided that the time is right for life insurance, the next step is to determine how much you need.
Life insurance agents and financial planners have from time to time recommended that their clients own multiples of their salary – for example, 5 or 10 times their annual income. You’ve probably even seen this recommendation on the Internet.
However, this approach does not take into account that the needs for life insurance vary greatly from family to family. It’s like going to the doctor and they all prescribe the same pill. Does not work.
When deciding on the amount of life insurance, you should consider your family size, career, assets and liabilities, and your goals.
Here are two different ways to calculate how much life insurance you need:
- A human life value approach
- Needs approach
RELATED: How much should I save for retirement (by age)?
A human life value approach
You cannot truly value human life, but for insurance purposes you can. First, we’ll look at what the present value of all of your future earnings is. The goal here is to provide income for your family in case you die unexpectedly. Here’s how to do it:
- Take your average annual income
- Subtract taxes, health and life insurance premiums, and personal care products to get the amount you need to support your family each year.
- Find out how old it is before retirement
- And then let’s use a fairly reasonable discount rate to get the number.
For example, Let’s say Scott (27) makes $ 50,000 a year, and for the sake of simplicity, plans to make that on average annually until he retires at age 65. He is married and has one child. $ 10,000 is deducted for taxes, insurance premiums and personal care products, leaving $ 40,000 to support his family. All of Scott’s future streams of income will be discounted back 5% to present value.
With a quick calculation, we get a present value of $ 674,715. That dollar amount is what Scott’s family would lose if he passed away. The great thing about this approach is that it measures the human value of a person’s life, not just a multiple of what they earn.
You need USD 674,715 with an approach based on the value of human life.
This method is the best way to measure how much life insurance you need, but it has many limitations. It does not take into account other sources of income, such as survivor’s benefit, retirement income or pension income.
Second, it does not take into account Scott’s profession, employee benefits, or future earning potential.
Third, it is assumed that costs will remain the same, excluding inflation.
Finally, and perhaps most importantly, 38 years of profitability. This can have a significant impact, as well as any unexpected life events, such as divorce, childbirth or death in the family.
It is difficult to get the exact amount of life insurance that you need. If you are looking for a more accurate number, lifehappens.org has a human life value calculator that takes into account things like age, gender, occupation, increased work income, consumption needs, employee benefits, and the salary of a working spouse. When you think about all this, the value of human life becomes much greater!
Needs approach
The second way to decide how much life insurance you need is to use a needs-based approach. This takes into account all the different family needs you may have and how they may change over time.
First, you will need to add up all of your current life insurance (if any) as well as all of your assets. Then subtract that number from the total required life insurance.
Some of the most common financial needs are:
- Immediate needs: Cash to pay for burial expenses, burial, medical bills, inheritance expenses, etc.
- Income needs: Initially, beneficiaries will need income to support their current lifestyle, as well as income to support future income.
- Retirement needs: This is when a lot of people start to take an interest in cash value life insurance, which we won’t get into.
- You also need to consider: When will the mortgage be paid, if the children or spouse are planning on going to college, dental overhauls, home repairs, and car repairs. All of this requires an extra level of care in a family where there is a mentally, physically or emotionally handicapped family member.
After you have identified the needs, the next part does some calculations to get the number.
Let’s look at an example first; David and Kelly are married and have two children, 6 and 4 years old. David (35) makes $ 60,000 a year as a marketer and Kelly (33) makes $ 35,000 as a teacher. David wants his family to be taken care of financially if he passes away.
He thinks he’ll need $ 15,000 for a funeral, $ 5,000 for a deductible and medical co-insurance, $ 12,000 to pay off an auto loan and credit card, and $ 3,000 for attorney fees.
David also wants to provide his family with a monthly income until his youngest child turns 18. Kelly reckons they could quite easily live off 75% of David’s wages at home. That’s $ 45,000 or $ 3,750 per month. Kelly may work part-time as the kids get older, but she doesn’t want to rely on that expectation.
Kelly and the children will be eligible for Social Security survivor benefits. Let’s say they get $ 2,000 a month from this. This leaves a requirement of $ 1,750 a month. Life insurance worth $ 294,000 will cover this until the youngest child turns 18.
Putting it all together, David would need a minimum of $ 329,000 in life insurance to cover the needs of his wife and children.
Kelly also requires a $ 152,000 mortgage, a $ 10,000 reserve fund, and a $ 80,000 education fund. Living more would be encouraged to improve the quality of life and pay for things like sports, vacations, renovations, etc.
You need USD 571,000 Approach to the needs.
The essence
By now, you should have a good idea of how to get the required amount of life insurance.
It’s time to put this policy into effect. Don’t let the topic of death get in the way of getting life insurance. The most important thing has something.
Even if it’s a $ 250,000 or $ 500,000 life insurance policy, it’s better than nothing.
If you are concerned about how much a life insurance policy might cost, you can request free quote from Bestow. With Bestow, you can purchase a policy for as little as five dollars a month and get rid of the hassle of agents and doctors. Getting the right amount of life insurance for your needs has never been easier.
Note
Neither Bestow nor the North American Life and Health Insurance Company contributed to the information for this article. The opinions and ideas expressed in this article are those of the authors and are not promoted or endorsed by Bestow or North American. Always seek professional advice before making a financial decision.
This post was originally published on Your Money Geek and is republished with permission.
