Have you ever asked an insurance agent, "How much life insurance do I need?" If so, you've probably heard one of us mention the "family needs approach." This approach asks you to make a rough calculation of your family's needs following the death of the person you want to insure. Once you know how much your family needs, you know how much life insurance you need to buy.
Here are a few guidelines to help with that calculation:
- Calculate your family's immediate needs if you were to pass away. Your family will need cash readily available to pay the deceased family member's medical expenses, funeral and burial expenses, estate settlement expenses, and debt liquidation expenses. Some planners also recommend setting aside a small fund that's available in the transition period (1-2 years) following your passing in order to pay off remaining obligations that you might not think of at first. These include things like car leases, health club memberships, and possible bereavement counseling.
- Calculate your family's ongoing needs. After the immediate post-death expenses are dealt with, your family will face ongoing expenses for food, clothing, and shelter. These "net income needs" will vary depending on your children's ages, your spouse's ability to earn income, your family's philosophy on how long it should support your children, and whether you have any children with special needs. You can estimate your spouse's monthly or annual needs for a period up through his or her remaining life expectancy. You can estimate each child's remaining monthly or annual income needs until age 18, or some other point when you expect him or her to be independent. One relatively simple option is to estimate that the survivors require around 70% of the deceased person's income before his or her death.
- Subtract your other sources of income. When you subtract your other sources of income from the total amount of expenses you expect to have, you get the leftover amount that your life insurance policy needs to cover. But what are these sources? Here are a few possibilities:
- Bank accounts (checking accounts, savings accounts, and certificates of deposit, among others)
- Savings bonds
- Real estate
- IRAs, 401(k)s, pension, profit-sharing plans, etc.
- Group life insurance through an employer or association membership
- Existing personal life insurance policies
- Investment assets (e.g., mutual funds, stocks, or bonds)
Tip: If your spouse doesn't currently work but would need to after your death, be sure to account for professional childcare expenses in the child-dependency period.