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Life Insurance Coverage Amount: The Formula

It seems like the million dollar question in life insurance policies concerns the amount: how much life insurance should you purchase?  While it could be a million dollars or deviate in either direction, potentially, it is one to approach with great care.  Having too little could be quite the unfortunate situation, and too much isn’t as great as it sounds.

The Formula

Sometimes the traditional way to do something is best.  As we will see, that is the case, while there is no magical way to come up with the number – plus, your needs will change.  However, we’ll get to that later; here is the formula:

Short-Term Needs + Long-Term Needs – Resources = Needed Life Insurance

Surely that is pretty straightforward, right?  You might want to think of it as more of a framework, as you can categorise as much as you want to make it yours.  Here are some specifics in the equation:

  • Short-Term Needs

When you pass away, you will need to cover your medical costs, funeral expenses, and the attorney and executor taxes.  Emergency expenses along with the string of debts that you’ll leave behind should be included as well: cash for medical emergencies, repairs to home/car; and credit cards, auto loans, student loans, and other existing bills.

  • Long-Term Needs

This can encompass a wide range of items.  Two traditional items are your mortgage and college tuition as applicable.  The latter figure can be difficult to ascertain; use typical costs of tuition and other stats to quantify it to the best of your abilities.

Look at other general expenses with your family.  This can be extensive, including food and clothing, utility bills, travel and transportation expenses, child care, and so forth.  You will want to multiply a number like this for the desired amount of years (hence re-evaluating this every so often; they’ll need less if you are 80 years old than 40 years of age, of course).

  • Resources

This one is pretty self-explanatory.  Include all of your investments and savings, and other types of life insurance products that you may have.

Don’t Take the Shortcuts

You might be tempted to take one of the “easy solutions” to figure out your number.  Don’t do it.

Possibly you have already seen them.  One idea is to only cover your debts, though that leaves out expenses that you loved ones will have to face, including those expenses in which they rely on your income.  Another is to simply multiply your salary by seven or eight – possibly a great start, but is hardly accurate and based on your needs.

Finally, the “human life value” looks at your salary and then calculates it based on salary increases – it only takes into account one element of our formula.

Overview

Use the formula to begin to see the big picture.  It will certainly help you identify key areas in which you can plan – and approach that number.

Re-assess it after a major life even or over time.  You won’t always need the same amount as you did 10 years ago. And as with any other type of insurance – Home Insurance, Car Insurance, or Health Insurance – Life Insurance is paramount to your family’s personal security.

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