Life insurance may not seem like a necessity, especially if you are young and healthy, have no dependents and have enough money to liquidate your debts and pay for your funeral. Nevertheless, if you intend to leave an inheritance to your loved ones after your demise, an adequate amount of life insurance, combined with other investments, may serve to replace the income that you presently provide for your family.
Key Factors to Consider When Deciding How Much Life Insurance to Buy
With that in mind, what amount of insurance would be adequate for your needs? The answer generally lies with the financial requirements of your dependents. To ascertain the optimum face value for an insurance policy that would best fit your family's needs in the event of your passing, the following factors should be taken into account:
- Replacement Income - typically the most important single factor to consider when calculating the face value of the insurance policy you plan to purchase. The face value on the policy should be large enough to replace the income you currently provide your beneficiaries. For example, if you generate the only income in your family and you make $50,000 per year, the face amount needed on the policy would be $50,000/5% = $1,000,000. Generally, one year's wages is added to account for inflation, so the optimum amount would be $1,050,000.
- Outstanding Debts - add the amount of all your outstanding debts and how much is needed to have them completely paid off. For example, your mortgage which may be $250,000 and a $5,000 car loan, totaling $255,000.
- Services - this consists of the services you provided your family which they will need to pay for in your absence. This includes subsidies such as health insurance received on the job that you have your family enrolled in.
- Future Education and Relocation Costs - add the amount of tuition, for sending a child to college or how much you would spend for your spouse's relocation costs.
Additional Considerations When Deciding How Much Life Insurance to Buy
Other factors should also be considered when calculating how much insurance you will need. These factors include:
- Insuring Another Family Member - insuring another family member's income could be beneficial in the case of a working spouse for example. Calculating the amount to add to the face value would be done as described above: income divided by the re-investment rate plus one year's salary.
- Death Expenses - add the amount of the cost of your funeral and legal representation for your family in the transference of your estate to your heirs.
- Death Benefits - these include benefits such as Social Security that your beneficiaries would receive in the event of your early demise. This, along with proceeds from other investments should be deducted in the face value calculation.
After calculating all of the above elements to determine the optimum face value of your insurance policy, you will have a much better idea of how much insurance would best meet your requirements. You will also be less likely to buy too much or an insufficient amount of insurance.