How Much Do You Need?
(Last updated on March 24,
Deciding whether you need life insurance is pretty
easy. Figuring out how much you need is not easy at
Many people just pluck some figure out of the air
that seems reasonable and settle on that. Some lean on
an old rule of thumb that says you need four to five
times your annual income. That's better, but in this day
and age you really should approach the problem more
scientifically. Use our How
much life insurance do I need? calculator or compute
an estimate on your own. Either way, here's what you'll
need to consider:
Immediate needs. What would it take
to pay off the mortgage or other debt and continue
funding the children's college funds. Don't forget about
funeral expenses, probate costs and, depending on the
size of your estate, estate
Future needs. Basically, you will
need to estimate the income your dependents would need
to maintain their standard of living if you were to die
tomorrow. Then subtract from that figure the income they
could expect to receive in social security survivor's
benefits (to get the form you need to estimate that,
visit the Social Security Administration Web site or call 800-772-1213).
Income when you're gone. Next,
subtract the salaries your dependents now earn or could
earn, the value of investments and other income sources.
The difference is the amount of income your life
insurance should provide. You have to make a number of
assumptions in the course of this exercise -- complex
assumptions that scare many people away from the
- What will inflation be in the future? Unless
you've got some special insight into this question,
assume that it will average 4%.
- Will the family be able to live on the earnings
generated by the proceeds of the policy, or should
they expect to gradually use up the capital as well?
The answer to this depends a great deal on how much
money is involved. If the policy will pay $500,000 and
there are other sources of income, then you can
reasonably expect that the beneficiaries could use the
earnings and leave the principal pretty much alone. On
the other hand, if the policy pays $100,000, then the
family will need considerable additional assets if the
principal is to remain intact.
- What rate of interest can you safely assume the
money will earn? For a conservative after-tax return
based on historical norms, you should assume
- Will your spouse take a job if he or she doesn't
have one now? Will that require a period of training?
How much can your spouse realistically be expected to
earn? The answers will depend on your own situation,
of course. It is impossible to anticipate everything,
but it's wise to make reasonable guesses about what
sorts of choices the surviving spouse might confront
and provide as much breathing room as you can afford.
You can see what makes this task so difficult.
Insurance companies will make the financial assumptions
for you, using computerized programs developed for the
purpose. These can be helpful, but many of the decisions
described above are too important to turn over
completely to the company trying to sell you the
Eventually you will have to pick some total insurance
figure that seems a reasonable compromise between what
you'd like to have and what you can afford, using the
companies' estimates for reference.
Keep in mind that the purchasing power of the
insurance you buy today will be eroded by inflation as
the years go by.