Determining the Need for Life
Insurance:
How Much Is Enough?
What determines your
life insurance need?
Life stages
and circumstances
When determining your life insurance need,
you should first consider your life stage and circumstances. Marital status, number
of dependents, size and nature of financial obligations, your career stage, and
your intentions to pass on your property are all factors to consider. Your need
for life insurance changes as the circumstances of your life change.
Starting out
In the "starting out" stage of
life, you may be just beginning your career or family. You may not have
children or other dependents at this stage, but that doesn't mean you have no
obligations. For instance, if you paid for your college education with student
loans, you likely had a cosigner for your loan--maybe your parents or a
grandparent. The same may be true of your car loan. If you were to die before
the loan is paid, your cosigner would be obligated to pay the debt. Under law,
a cosigner is responsible for full payment of a debt in the event of default.
Death doesn't erase the debt obligation.
Single adult
A growing percentage of the population now
falls into the single adult demographic group. This group covers a broad
spectrum of ages, lifestyles, and obligations.
Family
obligations--Parents
Although you may not have a spouse, your
death could have a serious financial impact on other family members. If, like
many adults, you are supporting your parents (either financially or with care),
your death could have a major impact, both emotionally and financially. They
would not only lose the support you have been providing to them, but they would
also need to come up with the money for your final expenses.
Family
obligations--Children
If you are a single parent, the primary
financial support for your children would die with you. If you are lucky, you
may have family members who would step in and help your children if you died.
If you are even luckier, they will be able to provide your children with the
education and lifestyle you had hoped for them to have. Your need for life
insurance as a single parent is even greater than that of a dual-parent,
dual-income household, which would still have one income if one parent died.
Life insurance is a cost-effective way to make sure that your children are
protected financially should anything happen to you.
Debt
obligations
In this stage of life, you may still be
paying for or even still accumulating education loans. You may have purchased a
house or condo with a cosigner. If you died, your cosigner would be legally
liable for the payments on the debt.
Protect your
insurability
Another reason to buy life insurance at this
stage of your life is to protect your future insurability. Once you buy a
permanent, cash value life insurance policy, it remains in effect for your
entire life (assuming the premiums are paid), even if your health changes. If
you were to experience a serious change in health, you might not be able to buy
additional insurance coverage, but you would still have the permanent coverage
you already own.
Dual-income
couple or family
If you and your spouse both earn an income,
it is possible that if one of you died, the other may be able to cope
financially on the remaining income. If there are mortgages, joint credit cards
or other debt, or children in the picture, the loss of one income could be much
more difficult to overcome. The more people who depend on your income while you
are alive, the more life insurance you should own. If you died today with
insufficient or no insurance, your mate could be forced to give up the
residence or lifestyle for which you have both worked. When there are children
involved, the loss of one breadwinner could mean a setback in the daily way of
life, not to mention any plans for private school or college.
Parent of
grown children
Just because your children have grown up and
left the nest doesn't mean you have no need for life insurance. You may have
spent your entire adult life building an estate that you intend to pass on to
your children, grandchildren, or favorite charity. You can use life insurance
to ensure that the bulk of your estate passes to your heirs or designated
charitable organization subject to certain tax advantages.
Part of
overall financial planning
Determining your life insurance needs should
not be done in isolation. Instead, it should be looked at as part of your
overall financial plan, with consideration given to your goals for savings and
retirement, as well as tax and estate planning. As your life changes, your
financial goals may change, as well as your need for life insurance, making it
important to also periodically review your coverage.
Methods of calculating life
insurance need
Several methods are used to calculate the
appropriate level of insurance for you and your situation. While they all share
common features, some methods strive to be more simplistic, while others
involve more sophisticated calculations. Some of these differences are
illustrated in the Table of Alternatives. You may want to determine an amount
on your own, using one of the simpler methods. This can provide a basis for
your discussions with your financial planner.
Insurable
interest
Before you begin calculating your insurance
needs, it is important to determine insurable interest. Basically, having an
insurable interest in a person's life means that you would suffer emotional or
financial harm or loss if that person were to die. It is always assumed that
you have an insurable interest in your own life. However, to prove an insurable
interest in someone else's life, you must have a relationship to that person
based on blood, marriage, or monetary interest. You must have an insurable
interest before you can purchase an insurance policy.
Family needs
approach
The family needs approach is one of the more
comprehensive methods of calculating your life insurance needs. It assumes that
the purpose of life insurance is to cover the needs of the surviving family
members. This method takes into account the immediate and ongoing needs of the
surviving family members, as well as income from other sources and the value of
assets that could be used to help defray the family's expenses (such as bank
accounts and real estate).
Capital
retention approach
The capital retention approach is one of two
calculation methods under the family needs approach. This approach assumes that
life insurance principal will support the family indefinitely into the future.
Because you will purchase more life insurance under this method, you will be in
a better position if the surviving spouse lives longer than expected.
Capital
liquidation approach
The capital liquidation approach is the
second of two calculation methods under the family needs approach. This method
does not provide as much continuing capital for the surviving spouse or for
heirs after the death of the surviving spouse. However, it does allow you to
spend less money by purchasing a lesser amount of life insurance coverage.
Estate
preservation and liquidity needs
The estate preservation and liquidity needs approach
attempts to determine the amount of insurance needed at death for items such as
taxes, expenses, fees, and debts while preserving the value of the estate. This
method considers all the variables of family lifestyle and the total cash
needed to maintain the current value of the estate while providing adequate
cash needed to cover estate expenses and taxes.
Income
replacement approach
The income replacement calculation is based
on the theory that the purpose of insurance is to replace the loss of your
paycheck when you die. This analysis determines an economic or human life value
and factors in salary increases and the effects of inflation in determining the
appropriate level of coverage. While more comprehensive than the rules of
thumb, this method still fails to consider special circumstances or financial
needs and operates on the premise that the current level of income provides a
satisfactory standard of living that will remain level throughout the future.
Rules of thumb
The rules of thumb are extremely basic
calculations. They provide a starting point but fail to recognize special
family circumstances or needs and focus only on the most basic components. One
rule of thumb dictates that multiplying your salary by a certain number will
provide an adequate level of insurance, while another calculates need based on
normal living expenses.
Insurance mistakes
No insurance
The worst mistake you could make concerning
life insurance is having a need and not having any insurance at all. Very
often, people can find all sorts of excuses for not buying life insurance. It's
no fun to plan for your death, for one thing. For another, there's the tendency
to think that dying won't happen to you, only to some person you read about in
the obituaries. But how many times have you heard about a young, apparently
healthy person dying suddenly in a car accident, leaving behind a spouse, a
young child, and no insurance? Sadly, it happens, and when it does, the family
faces not only emotional trauma but possibly an extremely difficult financial
situation, as well.
Not enough
insurance
The majority of people with insurance are
underinsured. Insufficient coverage can occur as a result of buying what is
affordable instead of what is needed. Failure to review your coverage periodically
could also result in insufficient insurance, even if you started out with
adequate levels. Inflation rates, your career, and your lifestyle may have
changed. Your family could be faced with a large financial gap and left unable
to maintain the current lifestyle if you died today. Consequences could include
loss of the family home, scaling back of college plans, and possibly years of
financial difficulty.
Too much
insurance
If you purchased a large policy during one
point in your life and then didn't adjust your coverage when your insurance
need was reduced, it is possible that you have too much life insurance. This is
another good reason to periodically review your coverage with your financial
planning professional. Periodic reviews of your insurance coverage can reveal
opportunities to change your levels of coverage to match your current and
projected needs.
CornerStone Financial
Whether your
nest-egg is worth millions or thousands,
You and your
family deserve it more than the government....
We are here to help you with all of your
financial and insurance needs. Our skilled professionals are licensed with
over 100 top name companies and can help you gain a better understanding of the
concepts behind insurance including investing, retirement and estate
planning. There are literally thousands of products to choose from,
but we can help pinpoint what is best for you and your situation. Please
do not hesitate to contact us if you have questions.
Contact:
Eric Tuttobene
President/CEO
CornerStone
Financial
(615) 427-8780
IMPORTANT DISCLOSURES
The
information presented here is not specific to any individual's personal
circumstances.
To the extent
that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties
that may be imposed by law. Each taxpayer should seek independent advice from a
tax professional based on his or her individual circumstances.
These
materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable—we
cannot assure the accuracy or completeness of these materials. The information
in these materials may change at any time and without notice.
