Guide to Determining How Much Life Insurance Coverage You Need

Life insurance helps people achieve financial goals and has never been more important. Life insurance typically protects dependent family members. Life insurance can pay for college for a child or grandchild. If if you have questions about life insurance, contact Abrams and we can assist you with all of these questions

Life insurance can pay federal and state estate taxes and estate settlement charges. Transferring wealth and making charitable bequests with life insurance is the ultimate gift. 

Understanding how to calculate insurance needs is crucial to using this powerful instrument to achieve financial goals. Because each case is unique, the insurance need must be assessed using the individual’s goals and objectives. Three common methods are used to calculate insurance needs. 

  1. Rule-of-Thumb 

This is the simplest way to calculate insurance needs. It examines how much insurance a family needs to replace a breadwinner and maintain their quality of living. Most people should insure for six-to-eight times their annual wage. There are two ways to improve this calculation: 

Multiply the breadwinner’s gross income by five, then add mortgage, debts, final expenses, and special funding needs (i.e., college expenses). 

Spend 6% of the breadwinner’s gross income + 1% per dependant on annual insurance premiums. 

This method can estimate the insurance need, but it doesn’t take into consideration particular conditions like the insured’s age, the age of the dependents, or whether the home is a one- or two-income household. 

2. Income Replacement 

This method calculates insurance needs using human value life. The technique values a life at the present value of its future earnings potential. 

The insured’s retirement income will determine the insurance needed based on after-tax income and its likely growth rate; an after-tax discount rate (or estimated future investment returns), and the insured person’s expected working years determine this amount. 

To establish an exact insurance need, consider many income adjustments: 

Since self-maintenance costs aren’t included in family support, the current income figure should be lowered. Since the insured is dead, any money spent on them will not support the family. 

After death, insurance premiums do not help the family. No longer paid premiums should be subtracted from annual income. 

When determining the family’s present quality of living, social security survivor payments should be included. 

3. Needs-Based 

Another easy technique for calculating life insurance needs is the needs approach. 

Final expenses (funeral costs, lawyer fees, probate costs), outstanding obligations (credit card, vehicle loan, education loans), and emergency expenses should be totaled up. Use the future value of money equation to calculate all long-term debts, such as mortgage and college tuition. Use the future value of money calculation to calculate family maintenance costs, including food, clothing, utilities, and transportation. 

Calculate a person’s needs and resources. All money, stocks, bonds, mutual funds, and life insurance policies are resources. 

After subtracting income needs from resources, life insurance should be considered. Eliminating unnecessary spending can change this amount. 

This study should be done every three years or after a major life event like buying a home or having a child. 

When used properly, life insurance can aid financial planning. Goals and priorities vary per person. One can help meet these demands by carefully assessing and choosing an insurance.