How to Calculate Your Life Insurance Needs

When it comes to protecting your family with life insurance, there is no magic formula that will calculate the “perfect” amount of coverage. One family’s financial situation and subsequent life insurance needs vary greatly from another’s depending on household size, household income, savings and investments, and individual goals. For this reason, we always recommend that you speak with a life insurance representative who can help you determine the best coverage to fit your needs. That said, there are a few common methods to get a ballpark idea of what amount of coverage is right for your family.

Buy coverage for specific goals.

You typically have a lot of flexibility when purchasing life insurance coverage. You can choose how long the coverage will last and the coverage amount, allowing you to be very specific when buying life insurance to cover a particular need. Consider the following:

• Funeral and burial expenses. Final expenses are expensive, and instead of passing those costs on to your loved ones, you can purchase a final expense life insurance policy or a permanent life insurance policy to pay for them. These policies can be smaller, on the scale of $10,000 to $25,000, but their permanence guarantees a payout for your family members in a time when money worries could compound their grief.

• College education. If you have children and want to provide funding for higher education, estimate the costs associated with education for each of your children and buy a policy in that amount. For example, if you have one child and want them to be able to attend a private four-year institution, you could purchase a $200,000 policy in a term length that would last through their graduation. If you have multiple children and want to pay for public colleges, you could consider purchasing a term policy for each child or one larger policy that accounts for all education costs. U.S. News and World Report shares the average cost of tuition and fees at different types of institutions each year, which can help with your calculations.

• Outstanding mortgage. If you own a home but still owe money on the mortgage, you can protect your loved ones from inheriting that debt by purchasing a life insurance policy in the amount of the outstanding mortgage for the duration of the mortgage (e.g., if you still owe $300,000 and you have 15 years of payments remaining, purchase a 15-year term policy with $300,000 of coverage). Given that housing is the top monthly expense for many families, a policy of this nature can relieve a lot of anxiety about having to sell the home and move to somewhere with a lower cost of living or find an alternative source of income.

• Debt repayment. If you have significant debt that might be inherited by a cosigner or otherwise financially burden your family members, it may be wise to purchase a permanent policy in the amount of your outstanding debt or a term policy in the same amount if you have a expected date by which you will pay off your debt. While some debt is forgiven with the death of the debtor, credit card payments, vehicle loans, and private educational loans all must be repaid even after death.

Buy coverage based on your family’s financial situation.

Add up all of your family’s financial obligations (including income replacement or the cost of replacing stay-at-home parenting services, outstanding mortgage balance, other outstanding debts, and other financial needs, like education or daycare costs). From this, subtract assets that your loved ones would be able to access in the event of your death to meet financial needs (including savings, college funds, and existing life insurance policies). The difference between these two numbers is an estimate of your financial need. Note that some of the obligations listed may have time limits – this can help you determine whether you want a permanent policy or a term policy (and how long you would want a term policy to last).

The U.S. Department of Veterans Affairs and Life Happens offer Life Insurance Needs Calculators that can help you estimate your coverage needs, and Navy Mutual’s representatives are trained in performing a needs analysis, which can not only help you determine what amount of coverage is best to protect your family, but also what type of coverage (term vs. permanent), and, possibly, the allocation of coverage between multiple policies.

Buy coverage to provide replacement income.

There are a number of rules of thumb that you could follow when thinking about life insurance coverage. One of the simplest is to multiply your annual income by the number of years you have left until retirement, and then purchase term coverage in that amount to last your family through to your retirement age. As an example, if you make $50,000 per year and plan to retire in 20 years, you could consider purchasing a $1 million term policy with a term length of 20 years. If anything were to happen to you while you’re still working, your family could rely on that policy’s death benefit to provide for them through to when you would have retired anyway.

There are some potential problems with this strategy, however. It may not work as well if you are young and have decades before you will retire or are highly paid. Life insurance policies may have an upper limit on coverage – if you’re only 30 years old and make $100,000 per year, with an estimated retirement age of 67, you would need $3.7 million in coverage for a term length of 30 to 40 years, which may be difficult to find.

A slight adjustment to this calculation can help bring coverage amounts down to more reasonable levels, while still providing the safety net that your family needs. Consider taking your annual income and dividing it by a conservative rate of return – this will provide you with the amount of life insurance coverage you would need if your family were to invest the full balance of the death benefit and live off the proceeds. This method provides replacement income for as long as they need it, and then the funds can be used to fulfill other financial needs. For example, if you make $100,000 per year and estimate a 5% rate of return (as might be found in a high-yield savings account), you would only need $2 million in coverage for a term duration that would last through your retirement age (which is much less than the $3.7 million needed in the example above).