We’ve covered lots of ground over the last few weeks on the topic of Life Insurance:
- The importance and benefits of life insurance
- Types of life insurance and their potential uses
- Employer sponsored life insurance and limitations
- Personal life insurance and ownership benefits
However, we have not yet covered the important step of establishing the level of life insurance needs.
I have noticed in helping clients establish their life insurance plan it is not uncommon for them to have some sort of death benefit in mind. This is usually a number arrived at by thinking about final expenses, or maybe paying off the mortgage.
Although these are important components of establishing a person’s life insurance needs – there are several additional aspects that need to be carefully thought through.
At the end of the day we need to be able to have confidence that our surviving family members will be able to maintain their lifestyle and have time to heal together – it’s that simple.
The good news is that you don’t need a PHD in mathematics to figure it out. In fact, I take my clients through a very simple 10 minute, 4 step exercise that allows a fact based, goal driven outcome to be developed.
It all starts with a blank piece of paper with 4 letters drawn out in a vertical fashion –
E. Education and final Expenses
Debt – This equals the total outstanding debt other than the Mortgage. Credit cards, lines of credit, auto loans, education loans, and business loans are the most common in this category.
Income – This is probably the most overlooked but yet most important category. What is your replacement cost? Any easy way to think about this is to calculate the future value of your earnings by simply multiplying your current annual salary times the # of years remaining until you retire.
If you have 20 or 30 years until retirement, best practice is to establish life insurance coverage to replace 8 to 10 years of earned income (after taxes). It’s also a good idea to put an inflation factor in there as well to account for wage growth.
Mortgage – this is straight forward – just be sure to include any home equity notes and time share type expense you may have.
Education and Final Expenses – this is where to include the cost, or perhaps a portion of the cost of college expenses for young family members. Final expenses are typically between $10K and $20K, I usually use $15K.
The last step in the calculation is to deduct existing coverage, perhaps the 2x salary group policy in place. Perhaps there is an old personal policy out there….
However – it’s important to consider that a group (employer sponsored life insurance) is only going to apply while/if you are employed with that company. These policies are typically not portable. If you leave the company or become disabled, the benefits are lost.
That’s all there is to it. At the end of this simple, short exercise you will a number that will serve as a solid,fact based starting point for setting your coverage level.
Of course, it’s always best to seek the guidance and expertise of a tenured, licensed insurance professional. Establishing a coverage level is not complicated – but developing the right policy type and aligning features and benefits to your lifestage and goals is something completely different.
I will leave you with the below slide show – take a minute to click through the 5 infographics. My bet is that you will find them interesting and very likely relevant to you and your family!