How to Calculate the Amount of Life Insurance You Need
No one likes to think about life insurance coverage and determining the amount you need can be a daunting task. Every person's situation is different and your coverage needs are based on many factors including your age, financial health, and number of dependents. Below are three approaches to help you in calculating the amount of life insurance you should purchase.
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Instructions
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Multiply your current income times six. The general rule of thumb for estimating your life insurance needs is to take your yearly income and multiply that by 6. For example, if you make $60,000 per year, you should purchase a life insurance policy that provides at least $360,000 of coverage. While this may be the easiest way to calculate your life insurance amount, it is also the least accurate. If your family has special needs or you have a larger than average amount of debt, you will want to increase this number.
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Calculate income replacement. How much money would your family need to invest in order to receive a monthly interest or dividend payment that would replace the income you contribute to your family today? This calculation requires a little more work. Let assume that you currently make $60,000 per year. If you feel that 8% is a realistic return on investments, then you would need a policy that provides at least $750,000 in order to generate $60,000 of income each year ($750,000 x .08 = $60,000).
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The deep-dive approach. This is perhaps the most accurate and thought-intensive strategy. It requires that you look at many factors and calculate financial needs based on current assets and future goals for your family. A formula you can use for this is (Cash Needs Immediately Upon Death + Cash Needs for the Future - Current Assets = Total Coverage Needed). While the formula itself is simple, gathering and estimating the inputs will take some effort.
Cash Needs Immediately Upon Death - This should include Mortgages (1st & 2nd mortgages + equity loans), Personal/Business Debt (credit cards, lines of credit, personal & business loans), and Final Expenses (funeral/burial & legal costs to settle your estate).
Cash Needs for the Future - This should include income for your family (you can use either Option 1 or Option 2 above to calculate this) and funds for your dependent's education. You can also include charitable giving if you so desire.
Current Assets - This figure should include your current cash, savings, investments and any employee benefits your family might receive upon your death.
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Once you have calculated each of the above 3 inputs, you can use the formula in the above step to arrive at a figure.
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Most people don't like think about death (especially their own). However, you should make proper arrangements now so that the people you leave behind don't have to struggle financially to survive in addition to mourning your loss.
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Tips & Warnings
There are many types of life insurance policies. Seek professional guidance in shopping for and selecting a policy that is right for you and your family.
