How Much Life Insurance is Enough?
Life insurance is the foundation of solid financial plan and it is important to make sure that you and your family are protected if there is an unexpected death. While each family has a unique situation that will determine their insurance needs, there are some factors that hold true for most people. Below are some typical considerations to help you calculate how much insurance you should have.
- Liabilities and Cash Needs
A good rule of thumb is to first and foremost ensure that your debt is paid off in the event of your death. Mortgages, lines of credit, and car payments are all financial strains that can be left on a surviving spouse. It is also prudent to account for new expenses that might arise if a spouse were to die unexpectedly. Would child care costs increase? Will the surviving spouse be able to stay on track to meet education savings goals? These are all things that should be taken into consideration when calculating life insurance. - Final Expenses
Funerals and other memorial expenses are not cheap. It is typically suggested that families plan for anywhere from $20,000-$40,000 in final arrangement expenses. - Income Requirements
While it is understandable that most couples avoid the emotional conversation of planning for an unexpected death, it is also important that you take the time to talk to your partner about what they would like their standard of living to look like if you were gone. Does your spouse make enough money to keep your current house, vehicles, and extracurriculars going if you die? For many families the answer to that question is no. - Families should plan to have enough insurance that they can take an income from the invested capital to keep their current standard of living for many years to come. The last thing a grieving family wants is to find out they can’t stay in their home or afford the things they used to. Retirement contributions, living expenses, and income shortages are all factors that should be broken down and included in your insurance plan.
Example:
30-year-old John and Jane Jones have 3 children, a new house, two cars, and a plan to retire at the age of 60. They want to make sure that if something happens to John that the family will stay on track financially, as Jane stays home with the children. They work with their advisor to add up the following:
- Mortgage: $400,000
- Car Debt: $40,000
- Education: $30,000 x 3 children= $90,000
- Retirement Contributions: $1,000 a month
- Housing Expenses: $1500 a month
- Other Income Needs: $2000 a month
- Final Expenses: $30,000
- Other Debt: $20,000 line of credit
The Jones have a lump sum need of $580,000 just to pay off their debt and pay for their children’s education. Jane will also need an income of $4,500 per month ($54,000 per year) for ongoing expenses to maintain their current standard of living. This means that they also need an additional $1,080,000 of investable capital (assuming a 5% annual return) to receive a yearly income of $54,000. The Jones have decided to buy $1,660,000 of insurance for John to ensure that the family will be secure if he were to die unexpectedly.
At the end of the day, life insurance is something that you buy for your family. No one wants their family to struggle financially in addition to losing a loved one. Taking the time to add up your family’s expenses and financial needs can bring everyone peace of mind. Now might be a great time to book a meeting with your financial advisor.
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