One simple way that life insurance needs are sometimes
estimated is to multiply current earnings by a given factor to estimate
the income that will be needed after a death. One approach assumes you need
70 or 75 percent of your income for seven years. For example, if you currently
earn $50,000 a year, this approach would estimate your life insurance needs
at $245,000 (70 percent) or $262,500 (75 percent). This may or may not be
the right amount of insurance for you. Your survivors may need to replace
your income for more or less than seven years. And if you invest the life
insurance proceeds and earn even three percent, you'll need less insurance
($225,000).
The needs approach is a better way to estimate life insurance needs. In
this approach, consider the following:
Immediate needs: Your family is likely to have several expenses upon
your death which may include uninsured medical expenses, funeral costs (which
averaged $4,600 in 1996), costs associated with settling your estate, and
(for estates larger than $600,000) federal and state taxes.
Survivors' living expenses: What will your survivors need in the
coming years to meet monthly living expenses? To estimate their' needs,
answer these questions:
a. How much will their living expenses be? (Seventy-five percent of current
expenses is a common estimate.)
b. How much income will your family have to pay these expenses?
c. How much income can your survivors expect from Social Security? (You
can get an estimate of your survivors' benefits by requesting and completing
Form 7004, Request for Earnings and Benefit Estimate Statement, available
from the Social Security Administration; call 1-800-772-1213 or visit their
World Wide Web site at http://www.ssa.gov/SSA_Home.html.)
d. How many years will your survivors need life insurance proceeds to help
meet their living expenses? (You may want enough insurance to help pay family
expenses, at least until you expect all of your children to be financially
independent.)
e. How will your survivors invest the life insurance benefits? (A more aggressive
investment strategy will mean a higher return and you'll need less life
insurance.)
Other future expenses: You may also want to buy enough life insurance
coverage to allow your survivors to set up an emergency fund, to pay for
child care, private schooling, or college, to repay your mortgage and other
debts, or to cover the costs of caring for a disabled child or elderly parent.
You can use the chart here
to estimate your survivors' financial needs. What investment assets do you
and your survivors currently have that could be used to produce an income
after your death? The difference is your life insurance need.
Example |
Your Family | |
| 1. Immediate needs (funeral, estate taxes, etc.) | $5,000 |
|
| 2. Survivors' living expenses | ||
| A. Expected average annual expenses | 29,000 |
|
| B. Expected spouse's average annual income after taxes | -22,500 |
|
| C. Annual Social Security benefits | -5,000 |
|
| D. Net annual living expenses (A - B - C) | 1,500 |
|
| E. Years until spouse is 90 | 55 |
|
| F. Investment rate factor* | x 22 |
|
| G. Total living expenses (D x F) | $33,000 |
|
| 3. Settling of mortgage and other debt | 12,000 |
|
| 4. Emergency fund | 10,000 |
|
| 5. Child care, private schooling, or college fund | 76,800 |
|
| 6. Other needs | 0 |
|
| 7. Total monetary needs (1 + 2G + 3 + 4 + 5 + 6) | $136,800 |
|
| 8. Total investment assets in hand | -10,000 |
|
| 9. Life insurance needs (7 - 8) | $126,800 |
| Years until spouse is 90 | 25 |
30 |
35 |
40 |
45 |
50 |
55 |
60 |
| Conservative investment | 20 |
22 |
25 |
27 |
30 |
31 |
33 |
35 |
| Aggressive investment | 16 |
17 |
19 |
20 |
21 |
21 |
22 |
23 |