Do you need life insurance? The answer depends on whether you have dependents–children, a spouse, or other people who rely on you for financial support. If you do, and you want to protect their financial health after you die, the answer is yes. If you don’t, life insurance is an unnecessary expense. It’s that simple.
The tough part is determining exactly how much insurance you might need. That’s because life insurance is designed to fill a gap between the financial resources your family would have if you died and what they would need. To know the size of this gap, you must know how much you own, how much you owe and how much you spend today.
With that information–and a little imagination–determining your insurance needs is a cinch.
How do you do it? You start with a copy of your household budget and your net worth statement–a simple listing of your assets and liabilities. With those you can figure out what you are spending today and where the income is coming from. You can also determine whether your demise–or the demise of your spouse–would create some long-term financial abyss. Would your death, for example, cause your family to prematurely lose a pension that’s been a pivotal part of your retirement planning?
From your list of assets, consider: What tangible assets could you liquidate (sell for cash) if necessary? What assets are you willing to liquidate? What current obligations (debts) could be paid off with the proceeds? Are the debts bigger than the anticipated proceeds or would the proceeds be sufficient to pay off the debts?
If your calculations include the sale of a home, be sure to estimate the home’s value conservatively–especially if you think you would need to sell quickly. And remember that even in the best of circumstances, houses can’t be sold overnight. At the very least, they’ll have to go through escrow, which almost always takes more than a month.
Now from your budget, consider: What expenses would evaporate if one of you died? What continuing expenses would the survivor be willing and able to cut?
What additional expenses might you face if one of you died? Would you be forced to hire a babysitter or pay for housekeeping services, for example?
Normally you would expect that certain expenditures–food, clothing, and transportation– are likely to decline somewhat if one member of a household dies. However, others are not. Chances are your rent (or mortgage) expenses will stay the same. Your child-care bills are likely to go up.
As unpleasant as it may be to think about, imagining exactly how your life would change if you lost your spouse is necessary to properly estimate your insurance needs. You need to consider the question separately for both spouses–even if one spouse doesn’t earn outside income. That’s because a stay-at-home spouse is providing valuable services, such as child care, food preparation and cleaning, that the other might have to buy in the event of a sudden death.
Those questions will help you determine how much monthly income your survivors would need if something were to happen to you today.
Your second step is to consider just how long they’d need that income. To do that, ask yourself:
How old are my children? Are they so young that my spouse would face either a day-care crisis or a financial crisis if he or she had to work more hours to help fill the economic gap that my death would leave?
Are the children’s college plans likely to be affected by my death?
How would my death affect the retirement plans of my spouse?
If my spouse is not currently working, is he or she employable today? Would he or she be employable in the near future, without job training or further education? How long would it take to make my spouse employable? How long would it take before my spouse’s income could more than make up for the income that he or she lost when I died?
The length of time that your survivors will need income will have a pivotal effect on how much insurance you need. To put it simply, some families will need income from insurance proceeds for a few years, others will need income for life. But most will fall between these two extremes.
FIGURING YOUR INSURANCE NEEDS
– Calculate your current monthly expenses. If you are married, record the number twice, so you can calculate the insurance need for each spouse.
– Estimate expenses that would be eliminated if one spouse died. (For example, if you would jettison one of two cars, eliminate that car payment.)
– Estimate the increased monthly expenses you might have if one spouse died. (Be sure to consider items such as child care.)
– Record the income each spouse contributes to the family budget to determine how much income would be lost in the event of either spouse’s death.
– Using the information above, estimate what each spouse’s monthly expenses and income would be if the other spouse were to die. Subtract expenses from income to determine whether survivors would have a gap between the income they need and what they’re likely to have in the event of a death. If you come up with a negative number, you have an insurance need.
– For simplicity’s sake, multiply the gap figure by the number of months you expect this gap to continue, for a rough estimate of how much insurance you need. (For instance, a family may figure that their income would be lower than expenses for a few years, when the children need day care and financial support, but would diminish once they became independent.) If you would expect to need income from the insurance for more than five years, you should do the calculation explained below.
– To calculate a long-term insurance need, multiply your current monthly gap by 12 to come up with an annual amount. Then use the multipliers below to estimate the amount of insurance you should buy, according to the estimated period for which your survivors will need income.
For example, if you think your heirs will need $1,000 a month, or $12,000 annually, for 30 years, multiply $12,000 by 15.52 to see that you’ll need a policy worth at least $186,240. These multipliers assume that your heirs will earn a 5 percent annual inflation-adjusted return on the insurance proceeds.
The multipliers are 10 years: 7.86; 15 years: 10.54; 20 years: 12.63; 25 years: 14.25; 30 years: 15.52; 40 years: 17.28.
