We get this question a lot right after we ask this, “You mentioned needing $500,000 worth of insurance; how did you come up with that figure?” After an awkward but brief pause, they ask “So how much life insurance do you think I need?” This article is designed to provide a couple of options to answer that question.
I used three areas that need to be addressed in the event of an untimely passing. These are
- Overall debt- Overall debts can include-Mortgage(s), student loan(s), credit card(s)
- Replacing of lost income--Replacing lost income is one of the most important ones to figure out. I use the following formula
- With children still in the house
- 70% of the combined couples income still coming through the door
- Without children in the house, I use 50% of the income needed to be replace
- College - For education, I will use about $100K extra coverage per child
Let’s get specifics to see how this works
- and Mrs. Jones ages 39 and 40. Three very cute children ages 3, 4 and 5.
- Jones makes 50K and Mrs. Jones makes $150K
- Total income is $200K and 70% of that is $140K.
Now let’s assume Mrs. Jones passes unexpectedly, the goal is to get to $140K of total income. With Mr. Jones annual salary of $50K, he is short by $90K. So how do we generate that amount of income, through life insurance that’s how!
Let’s assume a 7% rate of return and divide $90K by 7% that will come out to just under $1.3M of insurance. Stated another way, if Mrs. Jones had $1.3M of life insurance and she passed and Mr. Jones invested the $1.3M and received a 7% rate of return that would equal about $90K of income on interest alone, without getting into the principal at all.
So with the above example, here is how it looks
- Total debt for the Jones - $400K (mortgage and one student loan)
- Replacing Income
- For Mrs. Jones - $1.3M
- Jones - $0
- Total education - $300K
So the total amount of coverage for Mrs. Jones will be $2M and Mr. Jones is $700K
**If either carries life insurance at work, add that amount into the calculation to reduce the amount needed.
After working through the numbers, I have had some of my clients look at me like I was crazy. I’ve heard, “That is way too much insurance!” or “There is no way I am leaving that amount to my husband!!” Again, this is just a calculation that is used to figure out how much life insurance is needed. Once you have a figure, we can back our way into what is comfortable for the couple.
At the beginning of the article, I mentioned a couple of ways to figure out how much life insurance is needed. The second option is using 10 times your current salary. If you do the math with our example, you will see that Mrs. Jones will need $1.5M and Mr. Jones will need $500K of coverage.
Regardless of the formula, make sure you talk through what the insurance is designed to do (i.e. pay off debt, replace income, college, funeral costs, etc.) Whether you use a firm like Innovative Financial Group-Atlanta or someone like us, take the time to walk through the exercise and make sure the protection you put in place will help your loved ones.
REMEMBER, it is not life insurance it is love insurance!!