How Much Life Insurance Do I Need?

First I would ask; how much would you like? Most folks purchase well below what they need, and would be allowed to own (yes there is a limit to how much Life Insurance you can own, just as there is a limit to how much a bank will let you borrow). There is a method I have used for many years. I call it the “Quick 1 minute answer method” to how much life insurance you need, here is how it works, say I am walking through the Mall (not likely as I go to the Mall once a year, maybe) and while in the Mall I am stopped by a friend that asks me.

“Hey Mark, how much life insurance do I need?”

Understand the person and I are both in a hurry for whatever reason (I’m in a hurry because I want to get out of the Mall as soon as possible) so my quick 60 second response is Minimum 6-7 times your pre-tax annual income, if your debt level is low, if your debt level is high, then at least 8-9 times and preferably 10 times”. Although more coverage is best, affordability is always a major consideration.

The “Quick 1 minute answer method” is both less involved and less scientific but is actually fairly accurate and is in line with the “Income Replacement” approach. Ultimately I tell my clients to buy as much as you can afford, don’t wait till you can afford more, buy what you can now. Here is an Income Calculator that can help determine life insurance needs.
Life Insurance Needs Analysis
How Much Insurance Do I Need?
Income to be Replaced:
Percent of Income Needed
Interest Rate:
Inflation Rate:
Number of Years to Replace
The next method is the “Needs Approach” approach. This is the long-math approach, as it requires the individual to complete a Needs Survey with various items on a Expense Sheet (these include mortgage or rental cost, uninsured medical cost, children’s education funding, funeral expense, etc) then tabulating and arriving at a number. Some areas of this are very subjective and individuals may either over or under estimate. Some items don’t typically appear on the survey form so people under-report without realizing it.

The other method is the “Income Replacement” approach this method is the easier of the two, very simply. What would your family need to replace your income? In other words, if your spouse received a Lump Sum and invested it to derive an income how large a Lump Sum would it take to replace your annual income? This method is more straight-forward, yet one variable is the interest rate at the time of death. For many years it was assumed a 6-8% return could be counted on in all economies, however, that has not been as of late, it no doubt will be again, but is not currently.

In all of these options we get into a quandary, are we replacing the income for a short-term number of years, lets say seven years, or a longer term, if a longer term and what income option are we using? With the Interest Only option, you will derive a lower income but the principal never exhaust, the second, Annuitization, in which the income is a combination of Principal and Interest, this option results in a substantionally higher income, and the Principal is being drawn down, there are numerous variations to this option. For any of these approaches to work at the lower Income Multiples clients should be aware that;

  • By Annuitizing the Lump Sum, or part of it, the income can be greatly increased, that is the monthly payments consist of Principal and Interest (this results in a substantially higher income than interest alone).
  • Most are not aware of an additional source of income. For couples with young children under age 16, the surviving spouse will receive Social Security income based on 75% of the deceased spouse full retirement income, additionally each child under 18 (19 if in school) will receive the 75% (there is a family maximum) this of course is based on the deceased qualifying, which is easier due to the new special rule, see: http://www.ssa.gov/pubs/10084.html

Below are the Life Insurance Income Multiples from one of the major Life Insurance carriers. As you can see a 40 year old is allowed up to 17 time’s annual income in Life Insurance, from all sources, excluding Group Life.

20-35 19x
36-40 17x
41-45 15x
46-50 13x
51-55 11x
56-59 10x
60 +    7x

Most clients I work with purchase enough life insurance to create a death benefit equal to 7-10 times earnings.