How to Calculate Your Life Insurance Needs
It’s hard to generalize when it comes to life insurance. What one family needs may differ drastically from what another family in similar circumstances requires.
How can you know if you have enough?
One way to determine how much life insurance you need is to peg it to 10 times your yearly income. This method, however, doesn’t provide much guidance to people who are not employed, such as stay-at-home parents.
If the spouse at home dies, the survivor may need life insurance funds to pay for the childcare and home maintenance costs that had previously been provided free of charge.
A better way to come up with your specific number is to figure out exactly how much money your family will need at the time of your death.
Start with your family’s debt, which includes mortgages, auto loans, student loans, and credit-card debt. Determine your future cash needs – the monthly amount needed to sustain the household – as well as any major future expenses, such as tuition, new cars, medical bills, and estate-settlement costs.
Add these together, then subtract your current liquid assets – whatever your family currently has in savings, such as amounts in bank and brokerage accounts and tuition savings plans.
As an example, say you are married with two children (for example, ages 8 and 6) and earn $50,000 a year. If you were to die now, you’d want to support your spouse for 15 years, until your youngest child is out of college. To do this, you’ll need $750,000 in income replacement ($50,000 for 15 years), $200,000 for two college educations, and $5,000 for funeral costs.
But you also may want to pay off the $100,000 you owe on your mortgage, the $10,000 in car loans and the $5,000 in credit card debt. That takes your total to $1,070 million. From that total, subtract what you’ve saved, and that’s how much you will need in life insurance.