Determining How Much Life Insurance You Need

by Stephen Nelson

When considering life insurance, you’re planning and preparing for an event most of us would rather not think about. But life insurance represents a critical step in managing your personal finances and ensuring your family’s well-being. The Two Approaches to Setting Life Insurance Policy Amounts You can use one of two approaches to estimate how much life insurance you should buy: the needs approach or the replacement-income approach. Using the needs approach, you calculate the amount of life insurance necessary to cover your family’s financial needs if you die. Using the replacement-income approach, you calculate the amount of life insurance you need to equal the income your family will lose. Let’s look briefly at each approach. You need how much? Using the needs approach, you add up the amounts that represent all the needs your family will have after your death, including funeral and burial costs, uninsured medical expenses, and estate taxes. However, your family depends on you to pay for other needs, such as your child’s college tuition, business or personal debts, and food and housing expenses over time. The needs approach is somewhat limiting. The task of identifying and tallying family needs is difficult, and separating the true needs of your family from what you want for them is often impossible. Replacing Income Using the replacement-income approach for estimating life insurance requirements, you calculate the life insurance proceeds that would replace your earnings over a specified number of years after your death. Life insurance companies sometimes approximate your replacement income at four or five times your annual income. A more precise estimation considers the actual amount your family members need annually, the number of years for which they will need this amount, and the interest rate your family will earn on the life insurance proceeds, as well as inflation over the years during which your family draws on the life insurance proceeds. Note: Do remember as you quantify the income you want to replace that Social Security provides generous survivors benefits if you’ve qualified. These benefits can easily total $2,000 a month or more. Calculating Replacement-Income Amounts with Excel If you’ve got access to a computer running Microsoft Excel, the popular spreadsheet program, you can use your computer to calculate the amount of insurance you need to replace a specified number of years of income. Suppose, for example, that you want to buy enough life insurance to replace the income from a $50,000-a-year job for 15 years. If you figure your family will earn 5% on the life insurance proceeds should the worst case scenario occur, you enter the following formula into a cell in an Excel workbook to calculate the replacement income life insurance amount: =-PV(5%,15,50000) Excel returns the formula result 518,982.90 indicating that you would need roughly $520,000 of life insurance, invested at 5%, to payout $50,000 a year for 15 years. Two Calculation Tips If you want to factor in inflation because you’re trying to replace income over a long period of time, you should use a real rate of return rather a regular, or nominal, rate of return. To calculate a real rate of return, subtract the inflation rate from the interest rate in the formula. For example, if you expect 2% inflation, you could replace the formula shown earlier with this formula: =-PV(5%-2%,15,50000) Here’s a final calculation tip: You probably want to round up your number. For example, if the formula provided earlier returns the value 518982.90, you might want to round up this value to $600,000. Or $750,000. About the Author: Stephen L. Nelson CPA has written more than 150 books. His bestselling book is Quicken for Dummies, which sold more than 1,000,000 copies. His books have sold more than 4,000,000 copies in English and have been translated into more than a dozen other languages. His web site is http://www.stephenlnelson.com Source: www.isnare.com

Why Buy Level Term Life Insurance?

by Greg Haehl

Term life insurance is often called temporary life insurance. Term life insurance is purchased to cover some type of asset over a fixed period of time. Term life has much lower rates than permanent plans because of these shorter time periods. Level term insurance is purchased to cover short intermediate-term obligations. The time periods can be 5, 10, 15, and sometimes 20 years. Short term debt is often covered by a level term policy. Family budgets are full of short term debt obligations. Families buy automobiles, appliances, furniture, and many other household goods and are in debt for these items over a short period of time. When you purchase these items you are often approached to buy credit life insurance to cover these obligations. It would be less expensive for a family to purchase a level term policy or rider to cover this kind of short term debt. Level term policies are better than credit life policies because the insured can choose the beneficiary. The credit company is often the beneficiary with credit life insurance and so the insured has no option in how to use the money at time of death. Level term policies are better buys to hedge against inflation. The decreasing term policy is a little less expensive but the coverage declines. The cost of goods and services never declines and so a level term policy will at least maintain its original face amount for the whole time period. You may want to compare level term rates and decreasing term rates. The difference may not be that much and so level term insurance may be a better purchase in the long run. The best type of life insurance planning includes a base of permanent insurance for life time needs and additional forms of term insurance for temporary needs. Level term life insurance is an excellent option for short term or intermediate term debt obligation. About the author: Our recommended quote sites Life Insurance Quote, Auto Insurance Quote, Homeowners Insurance Quote

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