Standard formulas for life insurance are very simplistic. It is said that your life insurance coverage should be eight to ten times your current annual income. So if your current income is $100,000, your life insurance should be $1 million. But what’s the basis for this?
Life insurance is a personal policy and it changes from one person to another. Even if two couples are earning the same salary, you cannot ask the couple with two kids and a mortgage to purchase the same coverage as a couple with no kids and who don’t have a mortgage. So here are some things to provision for, when you calculate your life insurance coverage.
Mortgage and other loans
Note down all your current loans and debts (student loans, car loans, mortgage balance and credit card loans). You dependents may or may not pay off the mortgage with the insurance money but that is on them. Nevertheless, the loans are going to be a very heavy debt on your dependents if you are not around so you have to provide for them in your coverage.
Education
Calculating college expenses is a bit trickier. You have to estimate the college costs at the time your kids go to college which may be many years from now. Then you will also have to decide whether you are going to pay the entire fee or just a part of it. College costs are actually increasing at the rate of 5% every year. What if you want your kids to go to a Ivy League college. Find out how much they are charging. Now add these expenses to your insurance coverage.
Replacement of income
After college funds, funeral funds, mortgage and other loans are paid off, your family will be better off. But there will be other expenses. Life insurance should enable your dependents to pay your house bills and live a comfortable existence when you are not there. How are you going to calculate this sum? Here is a method.
Calculating the remaining balance
Take 50% of your current pre-tax income and divide it by 0.05 (assuming the policy amount grows by 5% each year). If you are earning $60,000 currently, take $30,000 and divide it by 0.05. This will give you a sum of $600,000. Add all the other liabilities to this sum.
You are also going to have health expenses. So add another $100,000 (at the very least) to the final sum. At the risk of being a spoilsport, burial and funeral expenses also cost between $15000-$20000. These expenses must also be provisioned for in the coverage.
All these things might increase your life insurance coverage needs to more than $1 million. But don’t worry. You can actually buy a term insurance with this coverage, for a few hundred dollars every year. If you are willing to pay a bit more, you can opt for a whole life insurance policy, where the money you have invested in the insurance will be returned to you after a certain number of years, with interest.
If this is all too much and confusing don’t fret. If you are in Palmetto, Florida, we can help. Please contact Anderson & Associates to learn more about the life insurance options available to you.
