Another Way to Calculate Life Insurance Needs
When you purchase life insurance, one of the popular ways to determine how much is needed is by using a human life value calculation. According to the LIFE Foundation, the proper amount of life insurance is based on how much money your family (or other people who depend on you or will inherit your debts) will need after you're gone. You can use a calculator available from most life insurance agents or companies to determine your human life value. However, there is another way to calculate your life insurance needs.
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Process
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The process for calculating how much life insurance you need doesn't have to be complex. Life insurance is meant to pay off your financial obligations, whatever they may be, after your death. For this reason, a simple calculation can be performed to determine how much you actually owe in debts to others right now. Just add up all of your current debts. Add expected current and future financial obligations (i.e. the cost of raising a child, if you have one or supporting a spouse, if your spouse is financially dependent on you). The resulting dollar amount is the total financial liability you must cover.
Significance
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The total liabilities you are responsible for may be covered, in part, by future retirement benefit payments or other assets that you have now that could be sold. The actual amount of life insurance you need may be significantly less than your total liabilities, since your other assets will offset the liabilities. Future liabilities must be considered also. Are you planning to buy a vacation home? Do you plan to have more children? These estimated costs must be factored in as well. Once you have a rough idea of your future expenses, then you make your life insurance purchase accordingly.
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Benefit
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The benefit of adding up your current financial liabilities and roughly estimating future expenses is the simplicity of the method. Even if you are estimating future expenses, you may know that a home might cost you $350,000. Or, according to a 2005 report from the Department of Agriculture, a child may cost you $500,000 to raise until the age of 17. These costs can be quantified, and an appropriate amount of insurance purchased. By and large, simply adding these costs and purchasing enough insurance would be sufficient without the use of complex software.
Limitation
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The only limitation on a simple calculation method is that you must have a way to estimate inflation. It is unlikely you will know what inflation will be 20 years in advance, so you would need to purchase a policy which increases every year or purchase a level term life insurance policy with additional insurance being purchased at timed intervals to adjust your coverage upwards according to the actual rate of inflation that you've already experienced (after the fact). You may run the risk of falling short on insurance death benefits by purchasing life insurance after the fact. Life insurance policies with increasing death benefits are normally permanent life insurance policies, which come with premiums that are higher than term life insurance.
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