Aside from ensuring that you have the perfect insurance policy to fit your needs, it’s vital that you have enough coverage for you and your loved ones. Not having enough life insurance could leave your family with thousands of dollars of debts and other expenses that they don’t have the money to pay for. It’s a delicate balance between getting enough coverage and not paying for more insurance than you need.
There are several different schools of thought on how much life insurance one should purchase. Now that we have discovered that you do have a need for life insurance let us help you understand how much life insurance you may need. Our main purpose of having life insurance is to replace the income that we contribute to our family’s support and well-being should we die prematurely.
So Just How Much Life Insurance Do I Need?
There are three basic calculations that most advisors use today to determine how much life insurance should be purchased. There is the Rule of Thumb method, the Income Replacement Approach and the Needs Analysis Approach. We will take a quick look at all of these. The method I use can be coined as the Capital Preservation Approach and is really a simplification of the Needs Analysis approach. This is what makes the most sense to me.
Rule of Thumb – this is the simplest method to use and gets to the point rather quickly. This approach suggest that one needs an amount of life insurance equal to 8 – 10 times their annual income. For example, if you earn $100,000 per year then Rule of Thumb suggest that you would need $800,000 to $1,000,000 of life insurance coverage. While this is very simple and straight forward, it doesn’t take the entire picture into consideration. I will explain later.
Income Replacement Approach – By far the most complicated and most accurate method of determining the amount of life insurance that is needed. The Income Replacement approach to life insurance needs analysis is based on the idea that the ultimate objective of life insurance is to replace some or all of the earnings lost if an income-producing family member should die. In other words, the amount of life insurance coverage should equal the value of that person’s future earnings potential to the surviving family. This approach has been used in many wrongful death litigation cases.
The approach takes into account current after tax earnings, the projected earnings growth rate, the future working lifetime, and an after tax discount rate. In addition there are several adjustments that can be applied to further complicate matters. Computer programs are normally used to arrive at the amount of life insurance need with this approach.
Needs Analysis Approach – The Needs Analysis Approach consist of two categories. The first category deals with the immediate needs at death such as final expenses, debt liquidation, tax liabilities, educational expenses and an emergency fund. The second category deals with multiple period income needs such as the surviving spouse, children, and the surviving spouse’s retirement income needs. These two items added together will equal the amount of life insurance needed.
Capital Preservation Approach – Now hopefully you understand that true life insurance planning is more than just picking a round number like $500,000 or $1,000,000 and assuming that will be enough. The method that I use and feel is pretty simple to grasp is what I call Capital Preservation Approach. We take into account two areas. Just like the Needs Analysis Approach, the first is immediate cash needs at death, and the second is income replacement. Let me explain. Assume that you owe $250,000 on your mortgage and $50,000 on other debts such as credit cards and vehicle loans. Let’s take all of your debt and an estimate of final expenses (we will use $25,000). Next, we take education into account. This step is certainly optional but let’s assume that you have 2 children that you would like to provide an education fund for. Currently, 4 years of public college is around $90,000 (that is $180,000). Last is income replacement. Let’s assume that your after-tax income is $75,000 per year. I use a reasonable rate of return (currently use 5%) and divide that into your income to come up with income replacement. This is an amount that will continue for as long as the surviving family does.
Doing some quick math:
1 Cash needs at death – $325,000
2 Education Fund – $180,000 (may be optional)
3 Income Replacement – $1,500,000 ($75,000 / 5%)
Total – $2,005,000
There should be no doubt that we cover the bases with our Capital Preservation Approach. Not only do we liquidate the family’s debt and provide an education fund for the children, we maintain the same income level for the family. If you think that the income replacement portion is too large or small we can quickly adjust this number. You may have savings or a current life insurance policy that can offset this amount. Hopefully, you will pay off your mortgage and other debts. Your children will complete their education. As you get closer to retirement, your income replacement may be less due to retirement savings. You may only need this amount of life insurance for 10, 15 or 20 years. The message here is that life constantly changes. We can always change your life insurance plan to meet your changing needs.
Getting Cheaper Life Insurance
Regardless of how much life insurance you need, we can help you find an affordable policy that fits your needs. In most cases, the coverage is much cheaper than you would think. There are several things that you can do to ensure that you’re getting the best possible coverage for you and your family.
The first is to improve your health through diet and exercise. Both of these are going to improve your overall health and that translates into lower monthly premiums for your life insurance. When you apply for life insurance, the company is going to require that you take a medical exam. The results of that exam are going to play a major role in how much you pay every month. If you want to get cheaper insurance protection, you need to improve your health. If you’re overweight, then you could end up paying 50% more for your life insurance coverage.
Additionally, you can improve your health through cutting out any smoking or tobacco use in your life. Smokers have a much higher chance of being diagnosed with severe health complications, like a heart attack. That means that they are going to pose more of a risk to the insurance company. They are going to offset that by charging you higher premiums. Smokers pay an average of double for life insurance than what a non-smoker is going to pay. If you want a way to save thousands of dollars on your life insurance coverage every year, quitting smoking is an excellent way to do that.
The best way to ensure that you’re getting the best rates is to compare quotes from dozens of life insurance companies before you choose the one that works best for you. Each company is different and they all have various ways to calculate monthly premium rates and they all offer different plans. The insurance quotes that you receive from the companies could vary drastically depending on the one that you contact. Finding the best company is the difference in getting an affordable policy or getting one that’s going to break your bank every month. Instead of wasting your time calling dozens of companies, let us bring the lowest quotes directly to you. Don’t just listen to the advice from people on TV and radio such as Dave Ramsey’s advice on life insurance and Suze Orman on Life Insurance advice, we are here to personally work with you and your needs to get the best coverage for you and your family.
You never know what life is going to throw at your tomorrow. If something tragic were to happen to you, and you didn’t have life insurance coverage, your family would be stuck with a massive amount of debt and other final expenses. Losing someone close to you is never going to be easy, but being stuck with thousands and thousands of dollars of debt is going to make the whole situation worse.
Don’t wait another day to get the life insurance protection that your loved ones deserve. If you have any questions about life insurance or how much coverage that you should buy, please contact one of our agents today. We would love to answer those questions and connect you with the best possible plan.
If you’re worried about not having enough life insurance coverage for your family, contact one of our independent agents. We can walk you through the process and calculate your insurance needs.