How
Much Life Insurance Do You Need?
One of
the costliest risks that families face is the death of a breadwinner
(worker). This is especially true if a spouse and/or children depend
upon that person for all or part of their support. To protect family
members against financial disaster, consider the purchase of life
insurance.
There is no simple formula to determine the amount
of life insurance you need. Many factors must be considered,
including:
- current assets and current liabilities
- earning power of surviving family members
- other sources of income to the family
- projected expenses and family support
Carry too little insurance and you may not provide a
reasonable living for your family after death. Carry too much and
you may not enjoy a reasonable level of living while you're alive.
Many insurance companies have worksheets to calculate life insurance
needs. They total up a family's economic needs and subtract
available resources.
Worksheets generally include a total for
lump sum cash needs such as mortgage liquidation, debt repayment,
and final expenses. There are also calculations for the income needs
of children and a surviving spouse. After the total amount of money
needed is calculated, existing insurance and assets are subtracted
to determine the additional amount of insurance
required.
Once you have calculated the amount of coverage
that you need, choose an insurance product that is right for you.
There are two basic types of coverage which, in one form or another,
are the basis for virtually all forms of life insurance. The two
basic types are term insurance and permanent (cash value)
insurance.
Term insurance, simply stated, is insurance that
provides protection only for a specific period of time--this period
of time is called the term. Term insurance has no cash value or
investment value. Term insurance is one of the best ways to solve an
insurance need having a short or limited duration (e.g., the years
when children are dependents). It generally also has the lowest up
front premium cost.
Term insurance offers a specific amount
of protection for a given period of time. Each time the policy is
renewed, the premium increases to reflect the additional risk as an
insured person ages. Some types of term insurance, called level
term, may have premiums which only increase every five or ten years
or stay level for a certain number of years or until a given age.
The longer the time of the guaranteed premium, the higher the
initial premium will be.
Decreasing term was developed for
people having an insurance need which becomes smaller over time. It
is most commonly used when there's a declining degree of financial
responsibility, such as a home mortgage. With decreasing term
insurance, the level of protection declines over time, but the
premium remains constant.
Permanent life insurance combines protection
for the entire life of the insured person along with a savings
component known as the cash value. Annual premiums are fixed for the
life of the policy and are based on assumptions about interest and
mortality rates. These premiums may be payable for life or for a
limited number of years. Common forms of cash value life insurance
include whole life, variable life, and universal life. The main
difference between these different forms is in the method of cash
value buildup.
Most People Don't Have Enough Life Insurance
An agent selling life insurance may tell you to "buy now" because
your premium (insurance cost) will cost more later. Others
argue that if you don't need insurance now, saving your money and
investing it is better. This may be true. It depends on your ability
to save and your health. Before you decide to put off buying now,
consider your chances of getting an illness or injury later in life
that could make you uninsurable.
Children don't need life insurance unless they are family wage
earners. You, as head of the household, should buy insurance on your
life to protect your children in case of your early death. Again,
there is one exception. If you get support payments for a child and
these are important to your family's income, you may want to buy
life insurance for that child.
Say you've decided you need life insurance. How much is enough?
There is no simple formula that tells you the right amount.
One way often suggested to figure how much life insurance you
need is to use a formula. Some experts suggest buying life insurance
equal to five times your yearly income. Using this formula helps you
buy enough insurance for your family's current money needs. This
formula assumes that there is group life insurance from work for an
amount equal to one year's salary. It also assumes that the person
who will get the life insurance payment is eligible for social
security survivor benefits.
If both husband and wife work, buy insurance on both. You need
more insurance on the person with the highest income. For
example:
| You earn |
$15,000 |
| Spouse earns |
$20,000 |
Using this rule, buy life insurance
| on your life |
(5 x $15,000)
$75,000 |
| on your spouse's life |
(5 x $20,000)
$100,000 |
In this example, using the five times annual income rule, you
should buy $25,000 more insurance on your spouse's life than on your
life.
Other formulas figure in the income needs and financial goals
specific to your family, such as ages of your children, current
income, pensions, property, veteran's benefits, social security,
savings, health of your spouse and children and amount of money you
have to spend on insurance.
Remember, there is no final formula for
deciding the amount of life insurance you need. So be careful! Don't
buy it if you don't need it.
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