Do I Have Enough Life Insurance?
July begins the second half of the year, and this is a good time to review your life insurance coverage to ensure you have enough to protect your loved ones. Individuals who are the primary breadwinners in a household need to make sure there is sufficient financial resources for those who would be left behind in the event of a worst-case scenario.
Calculating your Life Insurance Needs
To determine how much life insurance your family will need if something were to happen to you, there are two important questions to ask:
- How much would my family need to meet immediate financial obligations?
These are the expenses that would be incurred at the time of your death. This would include your final expenses; such as funeral, burial, etc. In addition, you would want your family to pay off outstanding debts you may have, including credit cards, personal loans, auto loans and your home mortgage.
- How much will be needed to sustain the household until my youngest child is through college?
This is the amount of cash flow your family will need until all your children are through college. This would include the amount needed to replace your annual income (after taxes because life insurance proceeds are not taxed) multiplied by the number of years until your youngest child is expected to be done with college. You may also want to add in the cost to send your kids to college. If you already have a college fund set up, you can subtract the amount you have already saved.
Here is an example of what this calculation might look like for a family with three children ages 10, 12, and 15:
- Final Expenses: $15,000
- Unsecured Debts and Auto Loans: $35,000
- Home Mortgage: $175,000
- Annual Net Income of Insured: $50,000
- Number of Years Until Youngest Child Reaches Age 22: 12
- Estimated College Tuition for 3 Kids: $150,000
Immediate obligations add up to $225,000. The amount needed to sustain the household ($50,000 X 12) adds up to $600,000. Add in estimated college expenses, and the total comes to $975,000. In this scenario, a $1 million life insurance policy would be sufficient to protect your family.
You may choose to revise this figure down if you believe your family could still cover the mortgage payments if something happened to you and/or you want your kids to pay for their own college. In that case, the amount of coverage needed would be $650,000.
How Much Does Life Insurance Cost?
Life insurance is less expensive than most people believe. Modern medical breakthroughs have led to longer life expectancies, which has reduced the average cost of insurance. The cost of a $1 million life insurance policy will depend on the type of insurance you purchase (term or permanent life insurance), the health of the insured, and other factors.
Term policies are the most affordable, but they have an expiration date and do not accumulate cash value. For example, individuals can often purchase a 20-year term life policy with a $1 million death benefit for a couple hundred dollars per month or less. A shorter term (such as 10 years) and a lower death benefit can often bring the rates down to well under $100 per month.
Term insurance is ideal for those who are on a budget and need coverage for a specified period of time. Many individuals also opt for a term life policy with a larger death benefit to provide for minor children and until their mortgage is paid off, and a permanent life policy with a smaller death benefit to cover unsecured debts and final expenses.
What About Life Insurance through Work?
Many employers provide group term life insurance for their employees at a low cost. In some cases, there is a certain amount of free life insurance available (usually equivalent to one year of annual income), with options to purchase additional coverage. Coverage through work can help supplement the insurance you obtain on your own, but it does not replace an individual policy. The reason is that group term insurance through an employer ends if/when you leave your job.
Are You Adequately Insured?
Statistics show that most Americans do not have enough life insurance. Only 54% of Americans have life insurance at all, and of those that have insurance, more people own group life insurance than an individual policy. During this month, it is a good time to take a break from your summer activities to calculate your life insurance needs. You may be surprised by the gap between the coverage you have and what you need, and you may find that obtaining an adequate level of coverage is far less expensive than you thought.