Life insurance can help your loved ones if you die. Your life insurance beneficiary receives a death benefit, typically a lump sum of the policy face amount, that’s generally considered free from federal and state taxes. If you’re wondering, “How much life insurance do I need?” you must estimate how much money your beneficiary needs to carry on.
No one likes to think about death. Many life insurers offer special plans for your final expenses and, typically, you’ll pay higher rates if purchasing a specific burial plan. However, the average funeral is expensive. Your loved ones will need to pay USD 8,000 to 10,000 for a funeral. If there are unpaid probate costs, taxes on other assets, and unpaid medical bills, life insurance can pay for them. Consider the following areas to calculate how much life insurance you need.
How Much Life Insurance Do I Need: Income Replacement
If your beneficiary plans to stay at home to raise children or does not plan to enter the workforce, consider how many years your income must be replaced. How long does the family, spouse, or loved ones that depend on you for support, need the income you provide to make ends meet?
- If you have children and they need your income until college graduation, calculate the number of years between graduation age and current ages.
- If you want to provide income until a spouse retires, subtract his/her age from the retirement age.
For example, if you earn USD 60,000 a year and your child graduates in 20 years, you’ll need to replace USD 1.2 million in income.
To calculate survivors’ income needs in the future, analyze daily living expenses and big ticket expenses like a mortgage loan or college costs:
- Start with your family’s typical expenses. If your income is lost, your spouse might need to pay for child care to return to work.
- If a spouse plans to work, he or she might need new training or education.
- Consider the net income needed after taxes, not the gross amount when tallying expenses.
- If your beneficiary needs a new car or home, consider these expenses.
- Add these costs to the total amount of life insurance you need.
How Much Life Insurance Do I Need: Available Cash and Equivalents
Subtract the total amount of cash reserves and semi-liquid cash equivalents you have on hand. For instance, checking and savings, money market funds, Treasury bills, savings bonds, and similar funds reduce the amount of life insurance you might need.
- Don’t include retirement plans like IRAs or 401(k) employer plans in your calculation. These investments can change in value depending on market conditions. You’ll also pay tax penalties to withdraw these funds before age 59-1/2.
- Similarly, if you have an investment portfolio that’s built for the long-term, don’t plan on early liquidation to meet your beneficiary’s daily life or life event needs.
How Much Life Insurance Do I Need: Projected Financial Needs
Calculating your beneficiary’s projected financial needs and the time in which money may be needed from life insurance is a challenging exercise. If you’re a conservative individual, assume a short-term time horizon to determine your projected financial needs:
- Because savings rates are historically low, assume a less than three percent return for a time horizon of no more than five years on a conservative basis.
If you’re slightly more aggressive, use a time horizon of no more than 10 years and a four percent return. For longer periods, use an average six percent return rate. Adjust projected financial needs for a reasonable inflation rate. According to the Federal Reserve Bank, inflation is expected to increase as interest rates rise over the next few years.
Buy Enough Life Insurance for Your Needs
Many insurance industry experts believe that most Americans don’t have enough life insurance in place. Because the old adage that only death and taxes are certain, buy enough life insurance to take care of your beneficiary’s future needs. Term life insurance is widely viewed as an affordable financial planning tool.
Contact any of the nation’s largest life insurance companies to purchase the right life insurance policy for your needs. Knowing the answer to “How much life insurance do I need?” includes buying life insurance to meet your survivors’ future needs for replaced income, paying off a mortgage, education expenses, other life events, and even retirement.