How Much Life Insurance Do You Need?

The main objective for owning life insurance is to assure that your dependents can continue to enjoy their lifestyle in the event of the loss of a family income earner. The younger you are, the larger the role life insurance may have in your financial plan. Calculating "how much" and determining "how long" you need life insurance is key to family financial security.

How Much?

When determining the amount of life insurance that is required to provide for your family in their current lifestyle, you must consider both the immediate costs and the future needs. Consider the following when calculating your need for life insurance:

1. Immediate Costs. There may be costs associated with medical needs, memorial services, and the transition period for the spouse and family. It would not be unusual for such immediate need to be $25,000 to $35,000.

2. Debt Elimination & Education Funding. It is generally desirable to pay off the home mortgage and other loans to allow the spouse to be free of debt. In addition, setting aside the appropriate amount to fund a college education for each child can greatly reduce the future financial stress on the family. For this step, add up all outstanding loan balances and the lump sum needed today to provide for future college costs.

3. Funding Living Needs. A critical need of the family is the everyday funding of the expense budget. Start with the current annual expenses of the family. You can reduce this by the loan payments and education savings that have been satisfied in step 2. In some cases, the remaining living expenses, may be partially met by the spouse's after-tax earnings and/or social security payments that may be available to both the children and the surviving spouse. With this information in hand, you want to calculate the lump sum necessary today to fund the future net expenses. You need to consider the appropriate earnings and inflation rates as well as changing situations. For example, the working spouse retires.

4. Total Funding Need. Add up the amounts calculated in steps 1, 2, and 3. This amount represents the total funding necessary at your death to provide security for your family. If you have cash and investments equal to or greater than this required amount, you have met the family security need. If you have less than the required amount, you should purchase life insurance to make up the shortfall.

How Long?

The need for life insurance changes. Generally, a young couple with a mortgage and children have the greatest need for life insurance. As the mortgage is paid down, as the children finish college and become independent, and as you accumulate investment assets over time, the need for life insurance decreases. You can reasonably predict the mortgage payoff and the number of years until children become independent. This may be a good indicator of the length of time life insurance may be required to provide financial security for your family.

Type of Insurance.

You may be able to acquire your life insurance through your employer's group plan. This is generally the least costly means of providing coverage. If this option is not available or is insufficient to meet your total need, you will need to consider purchasing life insurance that you personally own.

You can purchase two types of life insurance, term and permanent. A term policy provides only a death benefit. You can purchase an "annual renewable term" policy in which the premium costs increase each year or every few years to reflect the age of the insured. The older you are, the higher the premium. At some point, it will become cost prohibitive to continue owning this type of policy. You can also purchase a "level term" policy. A "level term" policy provides coverage for a predetermined period of years, usually 10, 15, 20, or even 30 years. During the period of the policy the premium remains constant. A "level term" policy allows you to choose a policy that meets the period of need for your family.

A permanent life insurance policy combines a death benefit and a savings program. A portion of each premium is accumulated in the cash value account of the policy. The cash value is available for borrowing or withdrawing during the life of the policy. The permanent policy will stay in force as long as the premium is paid.

The premium for a permanent policy will be greater than the premium for a term policy with the same death benefit. A term policy is generally a better choice for a young family with limited cash flow.

Summary

Life insurance is an important element in securing your family's future, but it can be complicated. Estimate your need, do your own research on the Internet, and consult with a qualified advisor, such as a Certified Financial Plannerâ practitioner or an insurance professional.

Elaine E. Bedel, CFP®, is president of Bedel Financial Consulting, Inc., a fee-only financial planning and investment management firm. For more information, visit their website at www.BedelFinancial.com or email to ebedel@bedelfinancial.com.