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Do I Really Need More Life Insurance?
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You could go through complex formulas that the insurance industry have come up with so that financial planners can charge you (or impress you) or you can use the Rule of Thumb called CASH + ONE + ONE HALF as follows:
The CASH is simply enough cash to pay off all the bills you and your spouse have should something happen to you. One of the purposes of Life Insurance is to replace income when someone dies, and/or to provide a large amount of money to pay off bills or the other obligations one has.
If you have children your spouse would no longer have your income to pay the bills and your spouse would not be able to provide the logistical support involved with bringing up children. Would this present a hardship, the answer is probably yes. Would it be fair for your spouse to have enough money to a least pay off the bills?
Add up all the bills you owe; the total of credit cards, car loans, boat loans, home improvement loans, department store cards, and the mortgage on the house. You may also want to include the cost of replacing your car if it is several years old. Write that total owed next to the word CASH on your pad of paper. Now so far, that is the amount of life insurance that you need to pay off your debt.
The ONE of the formula is basically a one-year adjustment period for you spouse. If both of you are working, I would guess that you are using both your incomes to live on. The ONE is to provide a one-year adjustment for your spouse to adjust the family life style to a one-income earner family. It also provides a sufficient time period to adjust mentally to the pressures of being a new, single parent. Does is seem fair to provide for your spouse and children with one year of your income to adjust to your being gone, or do you think they would need longer to adjust to your absence?.
Take your annual income, you can adjust for taxes because life insurance isn't taxed, and write it down next to the ONE on your sheet of paper, or adjust it higher if you wish to provide for a longer adjustment period.
The ONE HALF part of the formula is simply to provide your spouse with half of your income until the youngest child is through college. This is important if your spouse doesn't remarry. It also provides some income to raise the children so that there will not be any undue pressure to remarry for economic reasons. Next you have to determine if it is fair to provide half of your income or if you would like to provide more. First take the income figure from step two and divide it in half. Take the age of 23 (approximate age when finishing college) and then subtract from it the age of the youngest child. This gives you the number of years to provide the income. Take that number and multiply it by the Half-Income figure and write down the total next to the word ONE HALF on your paper.
Now you add the three totals up and you will have the amount of life insurance that you should carry. You now can adjust that amount in a number of ways:
1. Take the mortgage amount out and substitute the monthly payment times X number of years.
2. Take some of the bills out of CASH because your spouse may have some income to pay these bills.
3. Reduce the number of years for the ONE HALF (assuming your spouse will earn more or remarry).
In other words test the initial figure for reasonableness and adjust that figure up or down until you get to a figure that is adequate but still affordable.
Determine what you owe. Determine what it would cost to replace your car. Decide how much annual income you would like to provide your spouse in order to make lifestyle adjustments to living without your income or services (i.e. In the case of a non-working spouse, their may have to be arrangements for child care or live in assistance, etc.). Then for the youngest child determine how many years before graduating from college, Then provide one half of a years income for each year to allow for expenses. Finally temper that figure with what you know about your family's lifestyle and what you feel you can afford. You can set up the following simple table:
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CASH + ONE + ONE- HALF |
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CASH = How much do you Owe? + possible Car Replacement Cost |
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plus |
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ONE = Your Annual Income X Years (the average is 1 to 3 years) |
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plus |
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ONE-HALF = Age of youngest child subtracted from 23 X 1/2 your annual income |
Add up the columns and determine the IDEAL amount of Life Insurance, then determine how much you can afford. Keep in mind that when your house is paid off and when your children are out of college you will be able to reduce the amount that you will need, but if your lifestyle becomes more elaborate then you should increase your coverage. Most Term Life Insurance policies will allow you to convert the policy to a permanent plan, which you could do when your needs are less (this is because the permanent policy will be more expensive for the same amount of coverage).