How to Calculate the Economic Benefit of Life Insurance

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Calculating the economic benefits of life insurance is the first critical step in estate planning. Some form of life insurance is a financial necessity for the vast majority of adults today. Life insurance can eliminate any financial burden on your heirs in the event of your death, and the importance of establishing life insurance is second only to drawing up a last will and testament in the responsible creation of your estate. Knowing how much life insurance to purchase is the first step.

Determine the length of time you need to be insured. There are two basic types of life insurance: term and whole life. Term life insurance pays a predetermined death benefit to your heirs in the event of your death during a specified term of coverage. The most common terms of coverage are 5 years, 10 years, 20 years, and 30 years. Insurance premiums are based on the face value of the policy and the length of time the coverage is in place, with longer terms demanding a higher premium. Whole life insurance remains in place until you die (or stop paying your premiums) and has no pre-determined term of coverage. It also accumulates cash value over the years that can be accessed in emergencies. Whole life is the more expensive of the two.

Calculate your liability exposure. Add up all your long-term debt. This includes home mortgages, car loans, credit cards, business debt, and any other type of debt you would want paid off if you die. This total amount is the bare minimum face value you should consider when purchasing life insurance.

Calculate expected expenses. Once you have you current liabilities totaled, it is time to determine how much you would need for substantial future expenses. These include the cost of college tuition for your children, wedding expenses, down payment assistance for your children's future homes, anything you anticipate needing to fund over the next 10 to 20 years. Once you have determined this figure, add it to your current liability figure.

Create an estate. Now it is time to decide how much you would like to leave your heirs after all the bills are paid. A good rule of thumb here is to multiply your annual income by five to offset the loss of that income to your family for at least five years.

Add everything together. The final step is to combine all the figures and get the final tally. This is how you calculate the economic benefits of life insurance. If you were to die while covered, all of your immediate liabilities would be paid, your children's college tuition would be paid for, and your family wouldn't suffer financially from the loss of your income. You can't put a price on that kind of peace of mind.

Tips & Warnings

• Life insurance death benefits are paid to your heirs tax-free.

References

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