Calculating Your Need for Life Insurance

We believe that life insurance serves an integral role in a family’s overall financial health.  While there are many rules of thumb that attempt to give people an idea of how much coverage is necessary, we generally prefer a more strategic and quantitative approach.

When calculating how much life insurance is adequate, we believe that people should consider the following current and projected future expenses needed:

Funeral Expenses & Short Term Cash Needs

Funeral costs are generally the most immediate need.  Although funeral costs can vary somewhat, for the purposes of calculating how much life insurance is needed, we generally estimate final costs to be in the neighborhood of $10,000.

In addition to funeral costs, we like to estimate a cash buffer that could be utilized to cover unknown expenses for the months preceding the death of a family member. Travel costs, attorney’s fees and time off from work would all be included in this category of expenses covered by insurance. 

Current Liabilities Such as Mortgage and Other Debt

In general, we suggest that people have enough life insurance coverage to pay off current debts.  While we would not necessarily recommend that life insurance proceeds be utilized to pay off all debts should a death occur, we do suggest that people obtain enough coverage to have this as an option should they choose. 

It is important to point out that, for most people, debts fluctuate with time.  Student loans are paid off. Mortgages go up and down as housing needs change. People buy investment properties and vacation homes. With that in mind, it is important to consider both current and expected future debt levels when calculating this component of a person’s life insurance need.

Anticipated Expenses for Surviving Children Including Education Funding

Most parents like to make sure that, in the event they pass away when their children are young, that there is enough life insurance coverage available to pay for their children’s education expenses.  This portion of the life insurance need will depend on the number of children, how much savings has already been accumulated for this goal, and how many years remain before college costs begin. 

The average annual cost of college including tuition, books and room and board currently averages in the $20,000 (public in-state) to $50,000 (private) range.  In addition, it is important to consider that college costs are currently rising at a clip of about 5% each year.    

Projected Future Income Needs of Surviving Spouse and Children

When it comes to estimating a person’s life insurance need, the hardest number to calculate is a person’s income replacement, or the estimated value of their future income.  That is, how much money would it take now, for your family to replace your income in the event of your death?

For those with spouses and children living at home, this can be a significant number.  Also, the more reliant a family is on one spouse’s income, the more insurance coverage will be needed for the primary earner.  It is also important to consider how much Social Security Survivors Income would be received and the possibility of changing family expense levels over time. 

Most Life Insurance Needs are Temporary

Under most circumstances, the need for life insurance coverage is temporary.  That is, as a person’s asset base increases, their debt levels decline and as dependent children grow up and leave home, the need for life insurance coverage diminishes.

For that reason, we believe that most people should buy term life insurance as opposed to other forms of cash value policies that tend to be more costly.   While there may be occasions in which permanent (cash value) life insurance is appropriate, we find that the vast majority of the time, term life insurance  is the most cost effective way to obtain enough coverage to protect families financially.