It’s sad to think this way but we will all die sooner or later. If you have loved ones who count on you to care of them, you should carry life insurance. But, the answer to the question wouldn’t be how much life insurance you need… but how much investment capital does your family need when you pass away.
There is a quick way to calculate how much life insurance your family needs. It’s not an exact method but it will help you get an idea before starting your detailed calculation. The quick calculation would involve five numbers:
- Immediate obligations: They are fairly easy to estimate. Let’s start with how much your family would need for funeral expenses. According to the National Funeral Directors Association, an average funeral did cost $7,755 in 2009 with only inflation considered this number is surely higher nowadays. So, you will have to start with that. In addition to funeral expenses you may consider adding your uncovered medical costs as well as your final estate-settlement costs.
- You will have to calculate the total of your debts. Debt can include mortgages, credit card balance and car loans but is not exclusively limited to those.
- Add-up the estimated costs of your children’s college education.
- Multiply your annual income by the number of years remaining until you retire.
- Add all of the above and deduct the value of your assets other than your home from the total.
Now that you have a general idea on how much life insurance coverage your family need, you will need to fine-tune your calculation. There are three formulas you can use to get a final and exact answer to your question.
The mortgage formula
In order to keep a roof above your family when you die, you will have to insure that they will be capable of paying the remainder of your home mortgage. If one member of your family has a full time job, it means that you will need half the mortgage amount in life insurance because you are sure that the working member can pay the mortgage and the extra cash from the insurance policy will be used for daycare and other expenses related to raising the kids. But, if you have two working members in your family, you will need double that amount in order to be sure that the mortgage can be paid even if one of the two members dies before the mortgage is fully-repaid.
For example, let’s say your mortgage is $400,000 and you have one working member in your family, you will need a life insurance of $200,000. But, if you have two working members, you will need a life insurance of $400,000.
Line Item Formula
This is the kind of formula that takes a lot of time but at the end you will have the most accurate estimation on how much life insurance your family needs. The Line Item Formula is an exact calculation of the basic expected expenses of your family should you die today. It consists of adding up all the expected expenses from mortgage payments, college, daily living expenses and childcare expenses to medical and any other expenses you can predict over the next few decades.
Income Replacement Formula
The benefit of a life insurance is not only tied to your mortgage but also helps insuring that your family will still have a monthly income after you die. To calculate the exact amount your family needs in your absence you have to add all the income you could have earned from now till your retirement. Let’s say you make $70,000, are 35 years old, and plan to retire at the age of 65, then the added income would be your annual income of $70,000 multiplied by 30 years. Your life insurance policy should pay your family around 2.1 million upon your death.
Always ask a life insurance expert
If you are curious and motivated enough, you can calculate how much life insurance your family needs yourself. Many, if not all, insurance companies offer you the study without asking for any commitment. But, it is very important to know the basics of life insurance calculation and compare it with the numbers you get from the experts. Some experts tend to inflate your insurance needs because they are paid based on commission. With the help of the above formulas you can know if your insurance representative is telling you the truth. Finally, always consider the advice of at least two experts in addition to your own calculations.