How Much Life Insurance Do You Need?

Making a decision to get your life insurance is the first step, and deciding how much life insurance you actually need is the second. In fact this is when most people make unreasonable judgments and it almost never fails that they start making up numbers which they think is suitable without basing it on any logical calculations. Yet sadly, some people even just want to buy the same amount of life insurance as their neighbors did.

Even though there are many approaches to determining how much life insurance you need, there are a few widely accepted approaches among the insurance professionals as follows:

• Multiples of Income Approach
• Financial Needs Analysis Method
• Capital Needs Analysis Approach

Since this is a vast subject to study, we will briefly examine each one the methods to give you adequate amount of knowledge to get you familiar with them.

Multiples of Income Approach: This is indeed the simplest approach where you can determine the amount of life insurance needs based on your current annual income. It is recommended that you should hold life insurance and liquid assets in amounts ranging from five to seven times your annual income.
However this approach ignores the amount of assets that you have already accumulated along with any amount of extra income such as trust and inheritance. Due to the simplistic approach of this method you may either over-insure or under-insure.

Financial Needs Analysis Method: This approach requires more sophisticated calculations to determine how much life insurance you need as to provide a sum of funds for your survivor’s needs in terms of (1) lump-sum and (2) ongoing income needs.

Lump-sum Needs at Death: These may include
• Probate and attorney expenses
• Final expenses
• Estate taxes
• Immediate emergency fund
• Payment of outstanding debt (i.e. mortgage)
• Short term, immediate expenses such as rent, bills, property insurance, etc

Ongoing income needs commonly include:
• Funds needed during the readjustment period immediately after death
• Income needs from the end of immediate adjustment period to the time when the youngest child becomes self-sufficient
• Income needs from the time when the youngest child is self-sufficient until the time when spouse starts receiving social security
• Income needs after the spouse starts receiving social security until the initial eligibility for pension

Since the purpose of life insurance is to fund the previously unfunded portion of these objectives, all existing resources that can provide part or all of these needs should be considered, and for simplicity and efficiency purpose, most of the planners suggest using a percentage of your current income as your target income level instead of calculating a combination of each anticipated need.

Capital Needs Analysis: This method is used to determine the lump-sum of money for your survivor’s needs without touching the capital and naturally requires a large sum of capital that will generate enough funds from the investments for your survivors.

It should also be mentioned that some insurance companies may also have their own methods of calculations as to how much life insurance you need.

Nevertheless the point is; it is quite illogical for someone to decide how much life insurance he needs without basing his calculations on some type of an accepted method. After all the basic propose of your life insurance is to protect the future of your loved ones as well as to protect your hard earned assets. Therefore, it is strongly recommended to consult an insurance professional who has experience developing a life insurance policy suitable to your personal needs.