Many people purchase their life insurance coverage for income replacement, mortgage protection, and/or to cover various expenses associated with the loss of a spouse such as medical or burial expenses, or counseling. While experts recommend that you purchase life insurance coverage five to 10 times your current annual income, this "rule of thumb" does not account for current assets or any special needs you and your family may have. Your life insurance needs will vary over time as your personal financial goals, needs and resources change. Let us help you determine how much life insurance you need.
Start With an Effective Life Insurance Coverage Plan
The starting point for an effective life insurance plan is to identify whether a risk exists and to define the financial impact of a premature death as a specific dollar cost. Several methods are used to quantify this amount.
Use the Simple Rule of Thumb
This method calculates your need for life insurance coverage as a multiplier of your annual salary or earnings. Five to 10 times earning is the simple rule of thumb. Clearly, this method is very simple; however. It does not allow you to address all of your individual financial goals. In addition, different advisors suggest different multipliers. This makes the calculation of a precise amount difficult.
Consider Income Replacement
This method focuses on the replacement of some percentage of salary or earnings for a specified period of time. The value of the income replacement can be calculated and compared to the assets you currently have. Any difference between needs and resources can be funded with life insurance.
While this method is not difficult to calculate, it may not adequately fund all of your financial goals if your present income does not fully represent these goals.
Evaluate Expected Financial Needs
This method focuses on the expected financial needs of the survivors, including:
- The amount of yearly family income needed.
- The number of years this income will be needed.
- Other anticipated expenses:
- Emergency funds
- College education expenses
- Medical, counseling, and burial expenses
- Estate settlement and administration costs
- Paying off debts
- Survivor retirement needs
- Special needs for children or other family member.
- The average annual percentage of interest your investments will earn.
- The expected average annual rate of inflation.
This method requires that you estimate the amount of the specific needs that are relevant to you. If you are married, you would consider the financial impact of the death of either spouse. Plus, you should evaluate how long each need will last and whether each need will increase or decrease over time. Knowing the duration of each need can help you select an appropriate insurance product. You should also factor in the impact of inflation on long-term needs.
Once you calculate the financial impact of a premature death, you can compare the amount to the resources you currently have available. If there is a difference, you can decide which needs to address first and begin to explore alternative ways to fund any shortfall.
Focus first and spend your premium dollars on those needs with the greatest financial impact and the most immediate time frames.