Posted : 01/19/2011
If you're thinking about purchasing a new life insurance policy, how much insurance you need is, quite literally, the million-dollar question.
Unfortunately, there may be agents motivated to sell you more coverage than you can afford.
To avoid getting stuck with a policy that’s not right for you, follow these four steps to estimating how much life insurance you should buy.
Estimating your life insurance coverage starts with calculating the cost of replacing your annual salary, according to Marlene Lemire, a financial service professional with Detroit Financial Group in Farmington Hills, Mich.
"That figure is going to depend on your age," says Lemire. "As people age, they usually have higher salaries and they always have fewer years of income to replace."
Lemire urges the following formulas for estimating how much life insurance you may need to replace your current income:
"That means that if you were 34 and you make $50,000, you should have about $1.5 million in life insurance for your beneficiaries just to replace your income," she says.
Next, factor in debts like credit card balances, auto and personal loans and mortgages.
"The biggest thing that you need to take into consideration are your survivors’ future expenses," says David Goldfarb, president of DSG Benefits Group, an employee benefits brokerage and consulting firm based in Dallas. "Funding for your children's education, family expenses, the cost of supporting your spouse – those all need to be considered, too."
Once you've calculated how much it will cost to replace your income, start adding in your portion of all of your family's long-term financial obligations including mortgage, college tuition and car payments, credit card bills, child support and spouse support.
If you're a single parent or your household's sole breadwinner, your insurance should cover 100 percent of these expenses. Those who live in dual income households can insure for less.
If you've made it this far, you're almost done. The last thing to add are your final expenses – the cost of burial, end-of-life medical fees and estate-settlement services.
Unfortunately, these can add up fast, leaving a huge fiscal burden for your survivors if your life insurance doesn't cover it. For example, the National Funeral Directors Association reports that the average cost of a funeral – not including cemetery plot, headstone or flowers – is $6,560.
According to the Life and Health Insurance Foundation for Education, a nonprofit insurance education group, you can estimate your final expenses by tacking on $15,000 or 4 percent of your estate – whichever figure is larger – onto your life insurance calculation.
Keep mind that if you pass on an estate worth $5 million or more, your beneficiaries will have to pony up a larger chunk due to higher estate and inheritance taxes.
If your figure is reaching gargantuan levels, don't worry – now you get to take out a few things. Subtract out:
If you're married and don't have children, you can also calculate your spouse's income replacement and subtract that out.
If you need some help with the math, Insurance.com's Life Insurance Calculator can get you started.
Regardless of what figure pops up, Goldfarb reminds you that it's just an estimate. Consider consulting a financial adviser before buying a policy, especially if you have outstanding circumstances such as abnormally high ongoing medical costs, or aging parents or relatives who depend on you financially.
"For someone who's older and earning more money than the average person, it would probably help to talk to [a financial professional] since life insurance can be used for so many things rather than just a death benefit," Goldfarb says. "How much you'll need really depends on individual circumstance."
Copyright © 1998-2013 by Quinstreet, Inc. All Rights Reserved. Insurance licenses