| |
|
|
 |
HOW MUCH LIFE INSURANCE DO YOU NEED?
|
|
| |
|
|
| |
|
|
| |
Determining how much insurance to buy requires you to invest some time in calculating
Your current annual household expenses
Your assets, debts, and other sources of income.
Weve provided a work sheet, which we will refer to in our discussion.
TIP: Find out how much insurance you need before considering which type of insurance to buy. Having enough is more important than having the right type. You should provide for your insurance needs immediately, although you can always switch to a more cost-effective or investment-oriented type of insurance later.
The ideal amount of coverage is the amount that would allow your dependents to invest the insurance proceeds after your death and maintain their desired standard of living without touching the principal. Although the old rule of thumbto buy five, six or seven times your annual salarymay serve as a starting point, it is no substitute for making the calculations to find out how much you really need.
By using the worksheet and our explanations, you will be able to make a fairly good estimate of your insurance coverage needs. You will need to make some assumptions about your familys future. Its important to be as accurate as possible in filling out the worksheet, since an underestimation could lead to your being underinsured, and an overestimation will lead to money wasted on unnecessary coverage.
Here is a line- by-line discussion of how to prepare the worksheet.
Line 1:Calculate The "Annual Income Needed"
Line 1 of the worksheet, "Annual Income Needed," is the amount that your survivors would need to live comfortably. It is important not to underestimate this amount. If there are recurring expenses that your family incurs but that are not shown on the list below, do not neglect to include these.
To arrive at the "Annual Income Needed," find the following amounts paid monthly. Then multiply the figure you arrive at by 12 to arrive at an annual amount. Add the following amounts:
Mortgage or rent, and other home-related expenses. Include your monthly mortgage payment, with insurance and real estate taxes, or the amount paid for rent. Also include the amounts you spend monthly on home repairse..g, plumbers, contractors, electricians, appliance repairand on home improvements. Add to this the amounts spent monthly on furniture, appliances, linens, and other items bought for the home
.
$___________
Heat, electricity, insurance (life, health, and liability) water, gas, trash collection, and other monthly bills
.
$___________
Food, including other items bought at grocery stores or drug stores, such as toothpaste, and including restaurant bills
..
$___________
Clothing
.......................................... $___________
Travel, including car payments, gas and oil, car repair, and car payments.. $___________
Child care or other dependent care
........................................ $___________
Recreation, including travel, gifts, theater, cinema
......... $___________
Other
............................................................... $___________
Total................................................................................................. $___________
Multiply by 12 and enter amount in Line 1 of the worksheet (below) ........................................... $___________
Line 2: Subtract "Other Sources"
The next item on the worksheet represents the income that your survivors will have. If there are sources of income other than the ones listed, do not neglect to include them.
TIP: To calculate Social Security benefits, you may wish to obtain an estimate of your benefit from the Social Security Administration. You can obtain a request form by calling SSAs toll-free number800-772-1213.
Since you cannot predict the amount your survivors will receive (it will depend on your age at death, your earnings, and the ages of your children), you may use the following as rough estimates: $4,000 per year if you have one child under 16, or $5,000 for two or more children under 16.
Do not include other insurance proceeds here; this will be accounted for later.
Line 3: Determine The "Shortfall"
Line 3 represents the shortfall, i.e., the amount you need your insurance proceeds to replace. This is determined by subtracting the "Annual Income From Other Sources" amount from the "Annual Income Needed."
Line 4: Determine the "Amount Of Proceeds Needed"
Line 4 is the amount that will generate the investment income needed to make up the annual "Shortfall" in Line 3.
The amount by which you should divide line represents the after-tax rate of return you can expect on the invested life insurance proceeds. The amount you choose to divide by depends on how conservative you want to be. It is reasonable for most people to expect an after-tax rate of return of at least 6%. But if you want to ensure that you are protected from inflation risk and interest rate risk, use the lower divisor of 4%. The middle divisor of 5% represents a "middle of the road" approach.
The amount you arrive at is the amount of death benefit (proceeds) you will need. The amount will be further adjusted as you work through the worksheet.
Line 5: Add the "Lump-Sum Expenses"
These are the items your family will have to pay for at the time of death. They differ from the "annual income needs" amounts in that they are not part of the familys everyday living expenses. Further, unlike the annual income amounts, they represent pure guesswork. If you wish to strive for a higher rate of accuracy, you can try to adjust these items for inflation, but this is not strictly necessary.
The estimate for funeral expenses should be at least $5,000. Depending on your desires and those of your family, you can adjust this figure upward.
The final medical expenses will be minimal if you have adequate health insurance. You can estimate this amount by finding out how much your policy requires you to contribute per illness.
The estate administration and probate costs can be estimated at 5% of your estate for the sake of simplicity. Your estate is the total value of your assets at death.
You will only owe federal estate taxes if your taxable estate exceeds the amount of the unified credit exemption equivalent. Your state inheritance taxes will depend on the laws in your state.
The "emergency living expenses" amount can range from three to six months worth of family living expenses.
The "debts" amount represents debts that your family desires to pay off at your death. Normally, it does not include items that make up the "annual living expenses"e.g., mortgage payments, car payments. However, if you decide that you wish to use insurance proceeds to pay off such expenses, then add in the amounts you estimate will be needed to pay off such debts.
As for future education expenses, it is suggested that you use an annual cost of $20,000 per child, per year, for the sake of simplicity.
Line 6: Determine the "Interim Insurance Proceeds Amount"
Subtract the "future expenses" on line 5 from the "proceeds needed" amount on line 4. This is the amount of insurance you will need to buy on your life. The amount will be further adjusted.
Line 7: Subtract the "Assets That Can Be Sold and Other Insurance"
For line 7, determine the amounts that represent assets that your survivors could liquidate to pay future expenses. Do not include any assets your survivors will be using to produce income that you included in "other sources." Also, note that you should include insurance payments and pension death benefits here, and not on the line for "other sources." This is because such proceeds will represent one-time payments, and not sources of annual income.
Line 8: Determine the "Total Insurance Needed"
Subtract the "assets that can be sold and other insurance" on line 7 from the interim insurance proceeds amount" on line 6. This is an estimate of the amount of insurance coverage you need.
Life Insurance Worksheet
ITEM YOUR ESTIMATE
1 Annual income needed.......................................................................... $__________________
2. Subtract other annual income sources:
Salary of surviving spouse and other family .............
$__________________
Estimated earnings on investments........................
$__________________
Social Security.....................................................
$__________________
Pension income....................................................
$__________________
Other income........................................................
$__________________
Total other annual income sources
$__________________
3. Subtract total of line 2 items from line 1........................ $__________________
4. Amount of proceeds needed (divide line 3 by 4%, 5%, or 6%) $__________________
5. Lump-sum expenses
Funeral expenses..................................................
$__________________
Final medical costs...............................................
$__________________
Estate administration and probate costs..................
$__________________
Federal estate and state inheritance tax..................
$__________________
Emergency living expenses fund.............................
$__________________
Debts to be paid off..............................................
$__________________
Education expenses..............................................
$__________________
Other lump-sum expenses.....................................
Total lump-sum expenses:
$__________________
6. Interim insurance proceeds needed (add line 4 and total of line 5 items) $__________________
7. Assets that can be sold and other insurance..................
Employer-provided group life insurance....................
$__________________
Other life insurance...............................................
$__________________
Death benefit from pension plan..............................
$__________________
Cash, savings.......................................................
$__________________
IRA, Keogh, and 401(K) plan lump sum amounts.....
$__________________
Other assets that can be sold................................
$__________________
Total assets:
8.Total insurance needed (subtract total of line 7 items from line) $__________________ |
|
| |
|
|
|
