How Much Life Insurance Do You Actually Need?

Life Insurance is one of those things that nobody really wants to deal with, but something that serves an important purpose. It's also an area of financial planning that can get unnecessarily complicated, very quickly. There are many different types of life insurance policies with various provisions and riders, but I won't be getting into that here. Today, I simply want to break down: How much life insurance do you actually need? Let’s consider a standard Term Policy. In the event of your death, how much coverage will be necessary to provide for your family? Let's break it down.

Life Insurance "Needs Analysis"

Determining Family Lifetime Needs

To determine how much life insurance you need on yourself, you first need to determine how much money your family will need to provide for themselves, in the event of your passing. 

Perhaps the most important cost that your family will encounter is living expenses. Look at how much they would need for food, clothing, housing, utilities, gas, travel, etc. Basically, everything your spouse/family would need to live on for the remainder of their lives. If your spouse does not plan to return to work, or plans to reduce working hours in order to care for the children, they will need funds to pay for the expenses that were once covered by your income.

One way to reduce their annual needs is by building in the cost of outstanding debts into your policy amount. For instance, student loans, auto loans, and maybe even mortgage. Not all of your debts are automatically forgiven upon your passing. While it depends on the situation and type of debt, your spouse may ultimately be responsible for the remaining debt. So add up all of the debt you have outstanding and considering tacking that on to the total coverage of your policy. This way, upon your passing, your spouse has the funds to pay off all debts immediately. 

Another expense that your loves ones will most definitely be responsible for paying your final expenses (funeral, casket, burial, cremation, etc.). While these costs range by state and extravagance, it could easily range from $5,000 - $12,000. To get an idea of how much it would cost for you, there are several websites that provide average funeral expenses, broken down by types of expenses and even average funeral costs by state.

 Once the funeral has passed and your family starts to begin this new phase of life, additional costs may be introduced. For instance, if you have younger children and your spouse plans to go back to work after you pass, you may need to factor in childcare.  This is not cheap and depends on the level of care and amount of time your children will need to be cared for. But to avoid having these expenses depend on your spouse's income, perhaps adding more coverage to your life to cover these costs. 

 Eventually, when your kids are older, they may consider attending college. Do you want your life insurance policy to provide enough to pay for college for your kids? College prices are as expensive as ever, and there are no signs of it getting any cheaper. There are several websites where you can get estimated costs of college, just to give you an idea. So maybe you want your life insurance policy to provide enough to pay for 100% of their further education, or maybe only 50%. Either way, it's worth exploring.

Finally, you may want to consider other goals or provisions for your family. Maybe you have aging parents that you'd like to provide for. Or perhaps you'd like to leave something for your siblings. Or maybe, you'd like to leave a small nest egg for your kids for business startup costs, or a down payment on their first home. These are all things to consider as well. 

Calculate Current Coverage

The Present Value of the sum of all of the things discussed above is your total Family Lifetime Needs. This is the sum total of what your family would need in the event of your death.  However, some of those needs may already be met through others means. For instance, existing life insurance policies, estimated spousal income, current savings/investments, estimated Social Security or Pension income. The Present Value of the sum of all these things represents the Total Needs that are already covered. 

Estimated Life Insurance Needs

Now subtract the Family Lifetime Needs from the Current Coverage to arrive at your Life Insurance Surplus/(Shortage).

Total Lifetime Needs (PV of family living expenses, outstanding debts, funeral expenses, childcare, college funding, other goals, etc.) - Covered Needs (existing life insurance, anticipated income, existing assets, etc.) = Life Insurance Surplus/(Shortage)

This is a great start point for evaluating life insurance coverage.

Consider Everything

As you can see, this is a detailed process and takes thorough consideration. If somebody approaches you about buying an insurance policy and that person doesn't know anything about your life, your family, your goals, your income, you spending habits, and everything we discussed above, then they can't know how much life insurance you need.

So take some time to consider all of these things before buying an insurance policy. But don’t let time get away from you because, as we all know, unexpected events happen. And having adequate life insurance can have huge implications on your family's well-being in the unexpected event of your passing.

Calculator

Here is a calculator you can use to get started: Calculate Your Needs | Life Happens

Alternatively, I can walk through this process with you at no charge. Feel free to reach out at andy@luminarywealth.com.