Buying a life insurance policy is no fun. Not only are you adding another expense to the monthly budget, you’re also forced to discuss things you’d rather not think about. No one wants to contemplate the death of their spouse or their self, but life insurance is a must. We’ve all learned in various situations that “it’s better to have it and not need it than it is to need it and not have it”; this is most critically true when it comes to life insurance. But how much is enough? Further, how much is too much?
Careers are built on this complicated topic, so there is no one-size-fits-all calculation. However, a good starting point is to consider these four components:
Final Expenses + Debt + Education Expenses + Income Replacement
- Final Expenses: This can vary depending on several factors; yes, like with most things, there are budget funerals and extravagant ones! On average, current funeral costs total just under $10k. Since this is not exactly pocket change for most of us, it is important to account for it.
- Debt: Total up mortgages, car loans, and anything that would place a financial burden on your survivors. Although they may choose not to pay off the debt, the funds should be available to do so if that is what they wish; otherwise they’d have to deal with selling the assets.
- Education Expenses: This expense varies significantly depending on the school; however, do your best to ballpark this number. Remember to aggregate how many children you plan to send to college and adjust for the annual rise in education cost (about 5%).
- Income Replacement: The “back of the napkin” formula is annual salary divided by .05, but check one of the many resources online for a income replacement calculator, which takes into consideration years to retirement, inflation, and annual rate of return. Using the table from The Motley Fool, the lump sum benefit for a $50k salary with 20 years to retirement is $840k.
Note: For a stay at home mom, the industry standard for financial planners is to use a “salary” of around $35k (equivalent of a full time nanny and housekeeper).
Example: Using the income replacement example above, plus $10k for final expenses, $250k in total debt, $60k for two children at four-year public universities, the total death benefit needed is $1,160,000.
Remember, this is on a per-person basis. You and your spouse will have separate policies so apply this separately to each of you to get an idea of the coverage each of you need.
Reasons to Adjust for More or Less
The policy you buy is a very personal decision and depends heavily on your particular situation. Some reasons you may adjust for a larger benefit include: a medical condition of one of the survivors in the family, insufficient retirement savings, or if the spouse that died is the one that provided health insurance for the family. Some reasons you may adjust for a smaller benefit include: the surviving spouse has a substantial salary, substantial retirement savings or pensions, or social security income.
How Much Will This Cost Me?
While a million dollars sounds like a lot of money, often the monthly payment on a premium for such a plan is less than $100 (sometimes much less), depending on the type of insurance, age, and health of the insured. It’s always a good idea to shop around before purchasing your policy, so you can compare not just prices, but also the size of the policy they recommend for your family.
Just Do It!
As unpleasant a topic as it is, purchasing life insurance is something you must do to protect your family. Like any other chore you don’t want to do, it is best to just do it now and get it over with! Then enjoy the peace of mind of knowing a financial safety net is in place. Just remember to reevaluate your needs after any major life event such as additional children or a major career change.