How to Calculate Your Life Insurance Needs

How to Calculate Your Life Insurance Needs

Life insurance is a wonderful tool to ensure peace of mind and financial stability for your family. It is designed to pay out a certain sum of money to a surviving spouse or family members in the event of someone’s death. This sum can replace lost income and pay off major bills while the family grieves and adjusts to life without their loved one.

And it doesn’t only have to go to children, spouses or other family members. You can choose anyone as your life insurance policy’s beneficiary and give anyone you care about financial support in the event of your death.

Life insurance isn’t free, though, so it’s important to weigh the cost of premiums against the potential benefit and make sure you aren’t under- or overinsured. Too little coverage will leave family members strapped for cash and too much is a waste of premiums, especially considering you hopefully won’t need the policy for a long time.

Whole or Term?

Any basic calculation of life insurance needs should begin by deciding if you want a whole life policy or a term life policy. Term policies have a fixed rate for a specific time period, usually ranging from 10 to 30 years. “The longer the rate is locked in for your policy, the more expensive it will be,” says Liran Hirschkorn, president of, a national life insurance broker. After the term expires, continuation of coverage will cause the premium to increase.

Whole life coverage is permanent coverage. The rate will remain the same until the day you die, regardless of how long you live. Because whole life is a guaranteed payout, it is much more expensive than term coverage. Whole life coverage also has some savings components and can build cash value.

Hirschkorn generally recommends people get term policies, “especially younger people, since you can get a lot more coverage for your money, and by locking in a rate for 20 or 30 years, you can have coverage while kids are young or until you pay off the mortgage.”

There are some instances where he’d recommend a whole life policy, however. These include: guaranteeing money for kids to pay inheritance taxes; a desire to leave money to a charity; or if you have a child with special needs who will need financial support well into adulthood.

Determining the Benefit Amount

Once you’ve determined the type of policy you need, the next step is to determine the benefit amount. “There are generally 3 schools of thought in this area,” says John W. Seltzer, CLU, a broker and CEO of J. Seltzer Associates.

The first method is to have a payout equal to 5 to 10 times the annual income of the insured. This is just a general rule, and where you fall — closer to 5 or 10 — will depend on how much debt you have, how much the surviving spouse makes and the size of your family, among other things.

“The second method, known as human life value, determines the lifetime earnings of the insured,” Seltzer says. Using this method, the present-day salary is calculated until about age 65, typically including a 3% increase each year. Then, a present value calculation is performed to determine what the amount should be in today’s dollars to achieve the eventual value of the person’s total income.

The final method totals typical expenses the family of the deceased will be left with. These include funeral expenses, the payoff of a mortgage, repayment of any other debts, tuition expenses for children and a general figure to replace lost income. “It is generally presumed that survivors will need 70% of that [lost income] amount to maintain their current lifestyle,” Seltzer says.

“Of course, all of these amounts are reduced by current savings, current life insurance, Social Security benefits and other benefits the survivors would be entitled to,” Seltzer adds.

Whichever method you use to calculate your benefit amount, be prepared to review it and adjust it annually as figures change.

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