In my 20 plus years of experience in the insurance field, one of the most common questions that comes my way is, “How much life insurance do I buy?”
It is one of the most common questions in insurance circles, and has one of the most complicated answers, too. I was even recently quizzed about it by Kimberly Lankford, the Contributing Editor at Kiplinger.
A life insurance policy, in essence, is a replacement of your income (so if you were to suffer from an untimely death, your family is not adversely affected in terms of finances).
In terms of the spectrum of coverage, life insurance has to be able to pay for all these things:
• Debt
If you’ve taken out a loan or mortgage, your life insurance policy has to have enough coverage so that all that debt can be paid and some payout is still left for the benefit of your dependents.
• Expenses
Considerations to make in terms of future expenses that need to be covered by life insurance must include the likes of estate taxes and funeral expenses that will be incurred at the time of your demise.
• The Future
You can’t anticipate every need that your dependents will have in the future, but there are a few definite ones such as education. If you have children, anticipate how much money they will need to complete their education. You don’t have to consider inflation, but make sure ‘college expenses’ also feature in your reckoning, if further studies have featured in your plans for your child’s (or children’s) education.
• Income Replacement
Your final consideration should be income replacement. Since your family depends on you to bring home the bacon, you need to make sure they’re covered for a decent period of time in the future, even if you depart. An easy way to calculate this figure is to take your current pre-tax remuneration, and multiply it by 10. So if you earn $60,000 annually, then you should set aside $600,000 to replace your income.
In summation, your insurance policy’s value should be equal to the amount of debt you have, expenses that will be incurred at the time of your death, education costs for your children where applicable, and income replacement.
So, the equation is:
Debt + expenses+ education + (annual salary x 10) = insurance policy value
If the figure you get reaches a million or beyond, that’s normal for someone with a robust pay package. As I mentioned in my interview with Kiplinger – for 20 years of term life insurance coverage amounting to $1 million, a 30 year old man would have to pay $421 annually, while a woman of the same age would pay premiums of $354. Not much of a financial outlay when your loved ones’ futures are at stake, wouldn’t you agree?