Many people do not like talking about life insurance — in times of health and relative ease, it can be an uncomfortable conversation. Moreover, the complexity of determining exactly who needs it and how much they need can be a little overwhelming. The number of people uninsured or under-insured continues to increase as more and more people forgo it altogether, unsure of where to find reliable information regarding life insurance. To help answer the first question, anyone who has financial dependents but does not have enough savings needs life insurance. Life insurance gives you a peace of mind by knowing that your dependents will be financially covered even after you have left them.
In the past, the formula for "how much" was seven to 10 times their total annual income, but that left many under-insured. It is good to keep in mind that there is no one-size-fits-all when it comes to life insurance. Take the time to crunch the numbers and discuss your family needs with your spouse to come up with a reliable estimate.
Now that you understand why you need life insurance, below is a simple four-step guide to help estimate the amount of life insurance you need.
Step 1: Evaluate Your Family Needs
First determine how much money it actually takes to run your household, including monthly expenses such as utilities. Also calculate your unpaid mortgage and outstanding debt. While at it, add all your funeral expenses and any possible estate taxes. Most insurance policies will cover expenses such as outstanding medical bills, funeral expenses, taxes, debts and even mortgage. Adding all these up gets you closer to the final estimate.
Step 2: Consider Future Financial Obligations
In your calculations, estimate the total amount of future financial obligations. This includes the cost of sending your children to college. Do not make a mistake of underestimating your family’s future needs. By doing so, you will be underestimating the amount of insurance you need, putting your family at risk of a financial shortfall. Make an outline of your family’s cash flow needs including long-term financial goals. Add all these factors up and you will have an estimate of the amount of money your survivors will need in the future. Don't forget to factor in the loss of your annual income and current financial quality of life. Remember, the higher your income, the higher your responsibilities and expenditures. This means that you will need more insurance to cover the income loss.
Step 3: Add up All Your Resources
Resources should be a sum of all the assets you currently have. Add up your spouse’s income, savings (whether long- or short-term), and any balances in your 401(k)s and IRAs. Remember to add college funds you have set up for your children and emergency reserves. Resources also include rental property in your name. If your employer provides any other life insurance policy for you, include that as well.
Step 4: The Calculation
Now that you have a rough estimate of your family's needs and assets, you can proceed to calculate your life insurance needs. The difference between your family’s resources and needs should give you an estimate of the life insurance you need.
You can opt to add a critical illness provision to your life insurance policy. This will give you peace of mind knowing your family will be financially protected if you suffer a critical illness and cannot work. Critical illness insurance policies cover illnesses such as cancer and heart disease. After you have taken life insurance, you should keep reviewing it on a regular basis so that if your circumstances change, it will still offer sufficient protection to your family.