How much life insurance do I need?


If you are looking for a universal-for-all formula to determine your life insurance needs, you will be disappointed. There is really no common formula that can be applied to everyone. Each consumer has a unique financial situation and therefore each would have a different set of requirements.

Having said that, here is what you can do to determine how much life insurance you need for your particular circumstances:

  • You can use an online calculator. If you go with this option look for calculators comprehensive enough to include all factors that should be taken into account. You can try our life insurance calculator - it includes detailed analysis of your assets and expenses to determine the right amount of life insurance for your needs.
  • Or you can do the calculations yourself. In this article, we will try to show you the factors that should be taken into account and add some examples in the discussion to give you a better idea on how you can approximate the amount of life insurance you need. Just follow the steps.

1. Establish your ideal life insurance amount

Step 1. Get your yearly income (after tax). For instance, $40,000.

Step 2. Then determine how many years there will be a need for this income after you die. Let us say, 40 years.

Step 3. Multiply the yearly after tax income by the number of years it will be needed after your death: 40,000 x 40 = $1.6 million

Step 4. Determine major events and how much they will cost. Events like college education, needs of children and other future major expense items. Let us assume that the amounts here total to $500,000.

Step 5. Add up the amounts in Step 3 ($1.6 million) and Step 4 ($500,000) and you get $2.1 million.

Step 6. Get the worth of your assets and liabilities. Subtract the total liabilities from the total assets to get your net assets. Let us assume your net assets amount to $100,000.

Step 7. Get the result of Step 5 ($2.1 million) and subtract from this the result of Step 6 ($100,000) and you get $2 million.

Step 8. Calculate the present value of the result of Step 6 by using a financial calculator or present value table using 2 percent as rate of interest. The present value represents how much is needed at present to be able to get to the future amount. Two percent is a realistic rate in that it is conservative and that past investment rates' performance are near that level.

2. Calculate the amount you can afford for insurance premiums

To do this, you should consider important expense items in your budget, those for food, shelter, clothing, other insurance payments, transportation, and etc.

3. Get price quotes from several insurance carriers

Ideally, your shopping list should have at least three providers. Do not rely on advertised quotes, as these may not apply to you. For instance, a carrier will advertise a policy with a $1,500 premium. If you are a smoker, this quote may not apply to you, as it may be applicable only to nonsmoking consumers.

4. Decide on policy ownership that will provide you with the optimum benefits

You may be the one whose life is insured by the policy. However, the owner of the policy may be your wife, a trust or any other individual who carries insurable interest in the event of your death.

When deciding on who should be designated as the owner of the policy, it would be good to look at possible tax implications. For instance, if the wife is designated as policy owner, certain estate taxes applicable to the policy's proceeds may be avoided. This is because if the one covered by the policy is also the owner, estate taxes may be imposed on the payout amount once the individual dies.

Check with a tax professional or an estate planner on how you can best use policy ownership to your advantage.

Possible scenarios

Using the steps prescribed above, let us have a look at the following scenarios and the approximate coverage amount:

Young couples with no children

Debt obligations of individuals in this situation are usually college loans or personal consumer loans. Other obligations tend to be at a minimum. In the event of a death, one concern is funds to cover for death-related expenses like funeral and or burial costs.

If both the husband and wife are working, and they do not own a home and have not accumulated a significant amount of debt, then the need for life insurance is not that great. There is no strong need to ensure protection of income for either spouse as the surviving spouse will continue working. There is also a great chance that the surviving spouse will remarry.

If ever there is a need for life insurance, the amount needed is expected to be under $50,000 for each spouse.

Home financed by mortgage

If there is only an individual involved, the home can be put up for sale and the proceeds used to settle the loan mortgage.

If a married couple is involved and the one purchasing the policy wants the surviving spouse to keep the home intact, the amount of policy to be purchased should take into consideration the outstanding amount on the home loan.

For instance, if the outstanding amount is $100,000, then the policy to be purchased should cover this amount. In addition to the outstanding mortgage amount, the coverage should also consider tax and home insurance payments.

Generally, those who fall within this type of situation would need coverage from $400,000 to $600,000.

Children - related costs

One of the reasons to get life insurance is to take care of the costs related to raising children. In the event of the covered individual's death, the coverage has to be sufficient to cover the children's financial needs.

Based on a study conducted by the Department of Agriculture, the cost to raise a child from age zero to eighteen is $226,920. College education would require an additional $21,447 yearly if the child will be enrolled in a public university within the state he resides.

For a newly born child, the initial coverage required would be about $300,000 counting college expenses. As the child grows older, the cost will see a reduction each year.

Costs related to a business

Estate taxes become due upon the death of a business owner. Coverage for this expense item is a problem for many small and medium sized businesses. Life insurance can be the answer as it can cover this obligation.

If the business is a joint partnership, a joint life insurance policy can serve the business regardless of who dies first.

Estate taxes for those leaving behind substantial wealth

A substantial estate is one that has a value over $1 million as per the current tax code. An individual leaving behind this much wealth will also be subjected to estate tax. A life insurance policy can ensure that this tax obligation will be taken cared of in the event of the insured individual's death.

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