Sure you need life insurance – but how much?

Chances are you recognize the importance of life insurance. If you have dependents that rely on the income you generate, there is little question they need the protection life insurance can provide. For most of us, it’s not a question of whether life insurance is necessary, it's a matter of how much coverage is needed. 

Like most people, you want to keep the costs of insurance under control, but you also don’t want to underestimate your actual need. The face amount of a life insurance policy may look significant, but that can be deceiving. For instance, a policy that would pay your family $500,000 upon your death may appear to be a windfall, but can it really provide for their living expenses over 20-30 years or more? 

Measuring the need more accurately

A financial professional can help you assess whether you have sufficient coverage, but you can do a quick self-assessment by considering three primary factors that go into the calculation: 

1.  Covering living expenses

One of the most important considerations is how much money your family will need to meet basic living costs over time if something unexpected happened to you. Although some expenses may be lower because one person is no longer living, don’t automatically assume that all expenses will be lower. For instance, if one spouse performed a number of household tasks that the surviving spouse would have a difficult time duplicating, it may be necessary to factor in the cost of hiring somebody to handle those tasks. 

There are several ways to calculate a ballpark figure for how much life insurance coverage you may need. One method is to come up with a workable number by calculating your average monthly living costs. Extrapolate that out over 12 months. When you settle on the annual cost of living for survivors, multiply that number by 25, and you will have a good sense of the primary life insurance need. This formula assumes that you can draw down 4 percent of the lump sum total to meet your annual expenses. Note that this formula is fairly simple, but determining how much your family might really need for their unique needs can be complex. You may consider using several different coverage estimate methods. It’s strongly recommended that anyone considering purchasing or changing their life insurance policy meet with a financial professional before making a decision. 

2.  Paying Debts

In an ideal situation, a portion of the insurance settlement could be used to pay off a mortgage, car loans, student loans and credit card debts. Then the family is not burdened with these expenses when an important income earner is no longer in the picture. Depending on the life stages of your family members, it may be difficult to determine these costs, but creating an informed estimate can be crucial to providing the right amount of coverage if something were to happen to you tomorrow, or fifteen years down the road. 

3.  Meeting savings goals

If part of your income is set aside to meet major financial goals such as funding college education for your children or retirement, those goals remain as important as ever when factoring how much life insurance coverage you may need. Whether applying a lump sum from the insurance settlement to meet these goals, or devoting a set amount of income annually to fund them as you do today, these goals should be accounted for. 

Adding these different aspects of life funding together will give you a basis for how much life insurance is adequate, but there’s more to consider. 

Adjustments to your estimate

Your family’s insurance needs may be reduced by other factors. A major consideration is whether a surviving spouse would earn income after the death of his or her spouse. Also, as a couple gets older, the total amount of replacement income required will decline assuming sufficient funding is in place for retirement. It’s important to re-evaluate your life insurance needs at major life milestones like a marriage or having a child, but it may also be worth it to re-evaluate every few years to ensure the coverage you have in place is still accurate. 

If your current life insurance coverage is based on simply guessing at how much is enough, it makes sense for you to use these tips, and consider meeting with a professional, to try to get more specific in determining an appropriate level of protection for your family. 

Rob Davis lives in University Place with his wife Lorri and sons Wesley and Parker. He is a Financial Advisor and CERTIFIED FINANCIAL PLANNER practitioner™ with Ameriprise Financial Services, Inc. in Tacoma, Washington. Rob specializes in fee-based financial planning and asset management strategies and has been in practice for 35 years. He is licensed/registered to do business with U.S. residents only in the states of Washington, Idaho and Arizona. You may contact Rob at ameripriseadvisors.com/robert.g.davis. 

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.