Deciding whether you need life insurance is pretty easy. Figuring out how much you need is not easy at all.
Many people just pluck some figure out of the air that seems reasonable and settle on that. Some lean on an old rule of thumb that says you need eight to ten times your annual income. That's better, but in this day and age you really should approach the problem more scientifically. Here's what you'll need to consider:
Immediate needs. What would it take to pay off the mortgage or other debt and continue funding the children's college funds. Don't forget about funeral expenses, probate costs and, depending on the size of your estate, estate taxes.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Future needs. Basically, you will need to estimate the income your dependents would need to maintain their standard of living if you were to die tomorrow. Then subtract from that figure the income they could expect to receive in social security survivor's benefits (to get the form you need to estimate that, visit the Social Security Administration Web site (opens in new tab).
Income when you're gone. Next, subtract the salaries your dependents now earn or could earn, the value of investments and other income sources. The difference is the amount of income your life insurance should provide. You have to make a number of assumptions in the course of this exercise -- complex assumptions that scare many people away from the task.
For instance:
--What will inflation be in the future? Unless you've got some special insight into this question, assume that it will average 3%.
-- Will the family be able to live on the earnings generated by the proceeds of the policy, or should they expect to gradually use up the capital as well? The answer to this depends a great deal on how much money is involved. If the policy will pay $500,000 and there are other sources of income, then you can reasonably expect that the beneficiaries could use the earnings and leave the principal pretty much alone. On the other hand, if the policy pays $100,000, then the family will need considerable additional assets if the principal is to remain intact.
-- What rate of interest can you safely assume the money will earn? For a conservative after-tax return based on historical norms, you should assume 8%.
-- Will your spouse take a job if he or she doesn't have one now? Will that require a period of training? How much can your spouse realistically be expected to earn? The answers will depend on your own situation, of course. It is impossible to anticipate everything, but it's wise to make reasonable guesses about what sorts of choices the surviving spouse might confront and provide as much breathing room as you can afford.
You can see what makes this task so difficult. Insurance companies will make the financial assumptions for you, using computerized programs developed for the purpose. These can be helpful, but many of the decisions described above are too important to turn over completely to the company trying to sell you the policy.
Eventually you will have to pick some total insurance figure that seems a reasonable compromise between what you'd like to have and what you can afford, using the companies' estimates for reference.
Keep in mind that the purchasing power of the insurance you buy today will be eroded by inflation as the years go by.
-
-
Biden Wants a Higher Child Tax Credit and So Do Some Republicans
President Biden wants to revive the higher child tax credit and monthly advance payments, while some Republican senators have their own ideas for the popular tax break.
-
Long-Term Care Planning vs. Taxes: Finding a Healthy Balance
Many families discover that trying to mitigate the cost of long-term care can conflict with another common retirement concern — reducing taxes for retirees and their heirs.
-
Kiplinger's Retail Outlook: Consumers Are Still Resilient
Economic Forecasts Kiplinger's Retail Outlook: Sales this year are likely to be mostly stable, even as the economy slows.
-
Kiplinger Jobs Outlook: Finally, Signs of a Slowdown
Economic Forecasts The February jobs report signals a change in direction, but it may take time to arrive.
-
Kiplinger’s Interest Rates Outlook: Rates Likely to Rise Again After Banking Crisis is Over
Economic Forecasts Kiplinger’s Interest Rates Outlook: Rates Likely to Rise Again After Banking Crisis is Over
-
Kiplinger Housing Outlook: Housing Starts Continue to Fall
Economic Forecasts Kiplinger Housing Outlook: Weakness lies ahead for the housing market as high prices, mortgage rates ding affordability.
-
How Does Marriage Affect Your Credit Score?
Starting a Family While credit reports aren’t merged for married couples, individual records can affect joint loans. Learn the rules to ensure good credit goes along with a good marriage.
-
What Does Your Credit Score Really Mean?
Basics Your score helps lenders assess the likelihood you’ll repay a loan. It can also help you assess your credit health.
-
2021 Holiday Tipping Guide: 18 People You Should Remember
Basics Service workers deserve special recognition for the help they provide during COVID. That makes holiday tipping all the more important this year.
-
PODCAST: How to Complain (and Get Results), with Emma Patch
Basics In today's customer-service environment, getting through and getting results takes determination — and skill. We'll talk about techniques to help you get help.
