How Much Life Insurance Coverage Do You Really Need?
One of our physician clients asks:
I’ve been putting off buying life insurance, but now that I’m married with a baby on the way I need to do the responsible thing. I’ve settled on buying term insurance, but I’m not sure on how much I should get. I’ve talked with four agents and I’ve gotten for different numbers that all seem really high. One suggested that I should buy an amount equal to ten times my income. How much life insurance coverage do I really need?
With so much at stake, there is no reason to simply guess at the amount of life insurance coverage when it is nearly as easy to calculate a family’s precise needs. All that it requires is a few hours work, some frank talk with family members, a spreadsheet or financial needs calculator, and some number crunching. The end result will provide everyone with a better sense of why life insurance is important along with the rationale that everyone looks for in its purchase. Here are the fundamental steps to assessing your life insurance needs:
Identify Your Actual Needs
Identifying needs really comes down to matching your obligations up with your ability to cover them should the family lose the income of one of the breadwinners. It inventories debt obligations and final expenses, such as funeral and medical costs. It looks to future obligations such as college funding to ensure funds are set aside today. It considers the ongoing income needs of family members through the various stages of life and their capacity to replace the lost income on their own. It requires a critical discussion of life style needs, a surviving spouse’s ability to earn enough income, and any special circumstances. It addresses the question of whether your family should have enough to just get by, or to be able to continue to enjoy their current life style. As with any extensive list of needs, they would then need to be prioritized.
Crunching the Numbers
After clarifying and prioritizing your needs, you will then need to quantify them. This is fairly easy to do for the immediate cash need, such as final expenses (including funeral and potential medical costs), debt payoff (mortgage, credit cards, etc.) and establishing funds for future goals such as a college fund (based on the percentage of costs you would expect to pay).
Quantifying income needs is a little more intricate, but it is really just a matter of establishing an actual budget for ongoing living expenses – food, clothing, medical, education, career training, recreation, utilities, transportation, etc. – that assumes death occurs today. The budget should be adjusted after the child dependency years.
By calculating the total value of the future income stream, adjusted for inflation, and discounted to the present using a capital growth factor, you will arrive at a lump sum amount. The assumption is that this lump sum of capital that would be available to the beneficiaries would be invested at the assumed growth rate to provide the needed income. There are a number of free financial needs calculators available online that can help you crunch the numbers and solve for your family’s future income need.
By combining your immediate cash needs amount with your future income needs amount, then subtracting your available assets and life insurance, you will arrive at a net capital need which is the amount of additional life insurance coverage needed.
It is also advisable to seek the guidance of a well-qualified and trusted financial professional who can assist you in validating your own assessment and to find the right kind of life insurance policy.