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Financial LifeStage - How Much Life Insurance Do I Need?

Key Points

  • Quick example of need calculation
  • Earnings on death benefits are taxable
  • How much do you need/have?

Life insurance provides money to replace the money that may stop if a breadwinner were to die. It helps families maintain their standard of living, keep their house, and for children not to have to change schools due to a dramatic drop in income.

Here’s a simplified and quick way to estimate how much life insurance a family breadwinner may need.

(Hypothetical example for illustrative purposes only.)

You may be surprised by the amount you just calculated. Too high?

Using the example above, if you were to die and your surviving family (let’s say a spouse and two children) had a similar household budget as shown above, how much income would that $1,500,000 in total life insurance coverage provide as income per month?

Assuming, after expenses, a 4% return were generated each year, then .04 x $1,500,000 = $60,000. Even though the death benefit paid from a life insurance policy is generally income tax free, the earnings on that money each year are not income tax free. If your surviving family paid income taxes of 25%, that would leave $45,000 to spend each year. Divided by twelve months, your family would have $3,750 to add to your surviving spouse’s $5,000 monthly salary without distributing the principal (assuming the surviving spouse continued to work). That total of $8,750 is less than the monthly budget of $10,000. But there is one fewer consumer in the household, so expenses may be lower (one less mouth to feed, one less car payment, etc.).

Is a 4% annual return too low? Assuming that money must be earned each year to help your surviving family pay its monthly expenses, how much more risk would you take to earn a higher return? We think, after expenses, you would find that 4% would be a very respectable return, if it could be achieved every year—because it must be achieved every year. Your family would depend on it.

It sounds like that money may last forever. But think of how much longer your surviving spouse may live. Life expectancy is longer today than at any time in human history and it’s getting longer. If your spouse were forty, he or she may live to age ninety. A lot can happen in fifty years.

Inflation may erode the purchasing power of this principal amount. Even at a 2% inflation rate per year, after 50 years, $1 would be have the purchasing power of only 37 cents. Medical expenses, long term care expenses, college expenses, and other family financial needs during a fifty year period may also place demands on that money. $1,500,000 might not be such a generous number after all.

Click here for a complimentary life insurance needs analysis.

The hypothetical examples presented are for illustrative purposes only and do not represent actual or future performance of any specific product or investment strategy.

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