Contributed by: Josh Bitel, CFP®
Given the pandemic among other unfortunate news around the world, there has been an increased interest about life insurance quite a bit recently. There are many different ways to determine if, and how much, is needed.
As your life changes, so do your needs for life insurance. You may not need it when you are young and single. However, as you take on more responsibility and your family grows, your life insurance needs may grow as well. Below are a few rules of thumb I like to use to start the conversation.
Estimating Your Life Insurance Need
There are several methods that you can use to estimate your life insurance needs. While the actual calculation may be much more involved, these tricks can be used as somewhat of a starting point when having a conversation with an insurance professional.
Income Rule
My favorite rule of thumb is the income rule, which states that your insurance coverage should be equal to 7-10 times your gross annual income. (Other professionals may have other ranges, I like 7-10). For example, a person earning a gross annual income of $60,000 should have between $420,000 (7 x $60,000) and $600,000 (10 x $60,000) in life insurance coverage.
Income Plus Expenses
This rule considers your insurance needs to be equal to 5x your gross annual income plus the total of any mortgage, personal debt, final expenses, and special funding needs (college, charities, etc.). For example, assume that you earn a gross annual income of $60,000 and have expenses that total $250,000. Your insurance need would be equal to $550,000 ($60,000 x 5 + $250,000).
Family Needs Approach
The family needs approach asks you to purchase enough life insurance to allow your family to meet its various expenses in the event of your untimely death. Under the family needs approach, you divide your needs into three categories:
Immediate needs at death (cash needed for funeral and other expenses)
Ongoing needs (income needed to maintain your family's lifestyle, such as a mortgage payment)
Special funding needs (college funding, bequests to charity and children, etc.)
Once you determine the total amount of your family's needs, you purchase enough life insurance, also important is taking into consideration the possible accumulating of interest in your life insurance policy over a given time frame.
These calculations will merely scratch the surface on determining your proper amount of coverage. Several other factors, such as your line of work, size of family, post-mortem desires, among other things, may trump any of the other rules listed above. For this reason, your best bet is to have a conversation with an insurance professional to understand your own unique needs.
Josh Bitel is an Associate Financial Planner at Center for Financial Planning, Inc.® He conducts financial planning analysis for clients and has a special interest in retirement income analysis.
These policies have exclusions and/or limitations. The cost and availability of life insurance depend on factors such as age, health and the type and amount of insurance purchased. There are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition if a policy is surrendered prematurely, there may be surrender charges and income tax implications. Guarantees are based on the claims paying ability of the insurance company. The hypothetical examples presented are for illustration purposes only. Actual investor results will vary. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.