What You Need in Life Insurance

You probably already know you need life insurance as part of practically any financial plan. That being said, how do you determine how much you need?

Life insurance is much like taxes for many people. You know you should, and indeed, have to deal with it, but you really don’t want to. The stereotypical life insurance agent is enough to make anyone cringe. That being said, understanding why you need life insurance and what you need is going to make life a lot simpler when it comes to purchasing it.

The best way to think about life insurance is through the concept of risk management. What are the biggest risks to you and your family from a financial perspective? For most people, it is a sudden lack of cash or the loss of the primary wage earner. Common pitfalls could be death, disability or a large property loss. With the first two of these, the real problem is a sudden loss of cash on hand to handle debts. If you suddenly lost your job, how long would you be able to meet your mortgage and other bills? For most people, the answer is not very long.

With risk management, the idea is to eliminate the catastrophe of a financial situation. Life insurance is the answer. The idea is that you pay a relatively small amount annually to avoid being put in financial straits if something bad happens. Your family is going to go through an extremely tough time if you die in a car crash, but it will be ten times worse if they are worrying about losing the home and so on. To manage this risk, you can pay a bit now to avoid such problems down the road. I deny it. You deny it. At some point, however, we are all going to pass away.

When evaluating what you need in insurance, it helps to consider immediate and intermediate needs first. They are going to need money to pay things such as funeral costs, medical bills, monthly bills and incidentals. On a more intermediate basis, there is the issue of the mortgage on the home, any other outstanding debts, taxes, education costs and so on. The specifics are dependent entirely on your situations, which is why talking to a financial planner is usually a smart move.

Next, you need to determine the long term income requirements of your family. The best way to do this is to total up your gross monthly bills. Don’t skimp on them. You want a specific list of expenses so you have a good, hard number to work with. Include everything from the obvious of mortgage or rent payments to the sublime of entertainment costs and utilities.

Let’s say it totals $5,000 a month. If the primary wage earner passes away, where is this money going to come from and for how long? How long do you want there to be money on hand? If you have kids that are under age 10, do you want them to go to college? How is the surviving spouse going to pay for the college? As you can see, the numbers add up pretty quickly. At $60,000 a year, your spouse would need $1.2 million dollars in life insurance to cover the basic costs of living for 20 years. This number is actually low if you consider inflation. Throw in the cost of sending the kids to college and you are looking at a figure closer to $2 million.

The key to buying life insurance is to figure out realistically how much you need on a monthly basis and how long you want to provide for your family. Once you do that, it is time to go talk to the insurance agent.