How much life insurance coverage do I need?

Are you wondering how much life insurance to buy?

There are several ways to calculate how much life insurance is needed.

Methods vary. You should be aware of the different approaches, because depending on the source, you will get a different answer. We have found that the simplest method is often the best. Below are a few of these approaches.

The first thing to do is to determine your goals. Some examples: Are you looking to provide your survivors with life-long income? Are you planning to offset estate taxes? Do you want to provide for a simple inheritance to your children? Is it your goal that the insurance policy pay off major bills such as a mortgage, cars, college and weddings? Certainly goals will vary greatly, but as you can see it is important that you get a good understanding of what you want to accomplish with the purchase of a life insurance policy.

We strongly recommend using the services of a licensed insurance or financial professional, who can assist you in determining the correct policy face amount. For your personal use, here are several methods  used to determine the the amount of life insurance to purchase:

Method #1: Income X Factor-
The simplest method is to multiply your annual income by a set number or factor (anywhere from 5 to 15). For example, if you make $100,000 per year, a factor of 9 might be selected resulting in a life insurance policy set at $900,000. Though not exact, this method does give you a indication of how much insurance to purchase relative to the income that you are bringing in. An adjustment should be made for future salary expectation. This method is very commonly used.

Method #2: Estimate Policy Death Benefit to Generate Necessary Income-
In this method, you estimate the amount of the policy's death benefit needed to generate the required amount of annual income needed. For example, if you determine that your survivors will need $100,000 per year, you might purchase life insurance in the amount of $2,000,000 (i.e. $2,000,000  yields an ongoing annual income of $100,000 a year at a 5% interest rate).

To use this method you will need to determine how much in annual income your survivors will need. Get a pencil and paper and work through the following steps. Or, if you plan to use an online calculator (see “Getting Online Help,” below), review the formula below so you understand the concepts and can choose a calculator that works for you. Here’s what to do:

a) Determine how much money will be needed on an annual basis. Be sure to include any import future life changes such as college expense, mortgage paid, cost of living, etc.

b). Subtract any current of future other income (e.g. dividends, social security, etc.) from annual income needs. You now have the annual income that needs to be replaced

c) Now calculate how much life insurance is needed to attain the number determined in item 2. Using the example above: if you determine that your family will need $100,000 per year, a policy set at a face value of $2,000,000 would be required. This is based on a sustainable 5% interest rate.

Method #3: Purchase multiple policies for life changes-
If determining one set amount is cumbersome, this may be because you have several life changes that are difficult to reflect in one policy face amount. To simplify things, simply buy multiple life insurance policies. The idea here is to buy different policies with different fixed level premium periods. For example, you may only need insurance for your children for the next 15 years, but wish to provide your wife with coverage for the next 30. Simply determine the two differing face amounts and buy a 15 year and a 30 year fixed term policy.

From time to time you will want to revisit your financial situation. If an unexpected change in your life necessitates more life insurance, then buy more. Likewise, if something happens that eliminates or reduces your need for life insurance, then cancel a policy or get another policy for less coverage.

Getting Online Help - Online calculators and worksheets can assist you in determining how much income your survivors will need and how much life insurance you should buy to generate this income stream. Before you turn to these calculators, however, make sure you understand the basic concepts behind calculating how much life insurance you need to provide for your survivors (as described above).