When working with clients on developing their estate plans, a common question we hear is “Do I have enough life insurance?” What we have found is that most people do not have enough life insurance for their family’s needs. They just picked a number that sounds good rather than trying to calculate the actual amount needed to protect their family.
We have broken down the calculation for how much life insurance you actually need into 4 easy steps.
4 Steps to Estimate How Much Life Insurance You Need To Make Sure Your Family’s Protected:
1. Debt
First, you will want to look at any debts you want paid off upon death. Many of our clients want their mortgage paid off so family members do not have to worry about that. This is where you will also want to consider any final arrangement expenses based on your final arrangement plans.
2. Future Expenses
Second, you will want to consider whether there are future expenses you would like to fund. For some people, this means financing future education expenses for children or grandchildren. For others, it means funding a vehicle for when your children or grandchildren start driving.
3. Household Expenses
Third, you will want to calculate household expenses for your surviving dependents. An excellent place to start is by looking at your current household expenses. If you are currently paying a mortgage but want to pay that off, you can subtract that expense.
However, there may be new expenses that arise that you do not currently have. If you are married with children, your surviving spouse may need more help with childcare or tasks around the house. Your family members may also need money for time off work or grief counseling.
We have found that people are more likely to underestimate household expenses for their surviving dependents, so we recommend adding a little more to your initial calculation. It is always better to overestimate these expenses than underestimate them.
4. Add and Divide
Finally, you will want to add up your numbers from steps 1 through 3 and divide that number by 0.04. In the financial planning world, there is a rough rule of thumb that if you have an investment portfolio that you invest safely and conservatively, you should be able to trust that it will reliably produce at least 4% in income returns.
For example, if your expenses from steps 1 through 3 are $100,000, when we divide that by 0.04, we get $2.5 million, so we would want to ensure that you have a $2.5 million life insurance policy.
If you want the peace of mind that your family will be provided for, it is important that we determine whether any life insurance is needed to supplement your estate.