Determining How Much Insurance You Need

If you have a family and financial obligations, you probably need at least a minimum amount of life insurance.

As unpleasant as it is to consider, there is always the chance that you or your spouse will die unexpectedly, leaving your survivors financially strained. There’s no clearer argument for buying insurance.

“To the extent that your debts exceed your financial resources at death, there is no substitute,” said Joseph Belth, editor of Insurance Forum, an industry newsletter. “There is no other investment vehicle that will guarantee to pay (your beneficiaries) a set amount in the event of your death.”

What’s less clear is how much insurance you need.

Some experts that contend you should buy an amount that equals four to 10 times your annual income. Others maintain that that’s far too simplistic. Instead, insurance needs must be individually calculated.

They’ll depend on your age, financial resources, family status, debts and the number and ages of your dependents. Those with no dependents may not need life insurance, while those with large families could need a lot.

To determine specific insurance needs, some people may want to consult a financial counselor who could help them develop a financial needs analysis.

But consumers should be wary of commission-based planners. Some are insurance agents who have a lot to gain by selling you a lot of life insurance.

If you want to go it alone, or at least get a start on this analysis before seeing a planner, you need to take a close look at your family and financial situation, evaluate your goals and estimate your needs.

Here are some of the things you need to consider.

* Your budget. How much do you earn and how much do you spend each year? Spending would probably be a little more modest if one spouse dies, but not much.

* Age. How old and independent are you and your spouse? If one of you died, could your spouse handle most of your current monthly payments on his or her wages alone?

A one-income couple must consider how much insurance would be required to replace the income earner’s wages and provide for the family, possibly for the non-working spouse’s lifetime.

If one spouse is not working solely to take care of young children, the calculation should figure how long that spouse would need to remain at home before the children were in school or partly self-sufficient. Then consider how much this spouse is likely to earn when working and whether additional income would be required to maintain a certain standard of living.

The family should consider any additional expenses required to cover the stay-at-home spouse’s responsibilities if this spouse were to die. Could the survivor handle the cost of day care and housekeeping, for example, on wages alone?

Two-income couples should already have factored day care expenses into the family budget, and estimated whether they’d have enough to cover it if one wage earner died.

* Children. How many do you have and how old are they? Generally speaking, the younger the children, the greater your immediate insurance needs. But needs will probably diminish as they get older.

* Goals. What financial goals would you have for yourself or your spouse if one of you were to die? Would you aim simply to remain in the same community and same house on a somewhat tighter budget? Or would you want to maintain an identical standard of living, possibly even sending children to private schools and colleges?

* Other sources of income. Consider how much the surviving spouse would get annually from Social Security, company pensions and any company-paid life insurance before calculating how much insurance to buy. (You can get an estimate of survivor’s Social Security benefits by completing a form SSA-7004 and sending it to the Social Security Administration.)

After looking at all these variables, consider whether income will fall short of expenses for each year considered. The shortfall is the insurance need. Remember to account for inflation by increasing the needed amount by a small percentage--say, 4%--each year. Also make sure you leave yourself some latitude for one-time and unexpected costs, including medical and burial expenses, car repairs, etc.

Many people try to buy enough insurance to provide for these needs by investing the life insurance benefit, never spending the principal. Others may want to buy less insurance with the idea of spending the principal over the time that it is needed.