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Pushing a pencil to add up just how much life insurance you need isn’t easy. At first glimpse, the math can seem complicated. The subject–death–isn’t exactly appealing. Add to the discomfort a good measure of guilt and confusion. Still, everyone needs to confront the issue of life insurance. It’s an important financial tool that will assist your family in the event of your untimely death.
When trying to determine the coverage you need, experts advise you to stay away from shortcuts or easy solutions, such as buying multiples of your income. These may seem like quick fixes, but Acting New York State Insurance Superintendent Kermitt J. Brooks says one-size-fits-all formulas often overlook specific needs. “Consumers hear some advisers recommending that they purchase five to seven times their yearly income–in some cases agents will tell you to take out a policy that covers 20 times your salary,” he says. “The truth is that there is no hard-and-fast calculation.” Brooks, in fact, says the right steps include assessing your current and future obligations against your assets and overall financial strength.
STEP 1: Examine the reasons you need life insurance. They should be simple and clear: A policy is meant to provide your dependents a certain amount of income over a set period of time should you die. “Younger folk in particular need to view life insurance as income replacement,” says Dwight Raiford, a senior financial planner for the insurance company MetLife. “If you died today, it’s there to make up for all the income you’d earn during a normal life expectancy.”
Your policy’s payout, after all, is meant to go toward the bills, the mortgage, and tuition for your children.
STEP 2: Tally your current debts and obligations and balance them against current assets. Your mortgage, car note, credit card balances and loans will have to be paid off in the event of your death. It may be a wise idea to include a cushion to cover interest payments over time.
STEP 3: Calculations should center on the salary or income the policy will replace. Be sure to include a little extra to account for inflation; higher prices over time may decrease the buying power of the lump sum your dependents receive. You may also want to focus your number crunching on the time it will take your youngest child to reach 18 years of age. Future obligations, undergraduate college tuition in particular, should also play a part as you settle upon the right amount of coverage.
STEP 4: Figure out funeral and estate expenses (possibly the most sensitive issue). Your policy should include provisions to cover the cost of your burial or cremation. According to AARP, the cost of a funeral (including burial costs) can range from $5,000 to $10,000.
STEP 5: Once you’ve figured out how much insurance you’ll need as a safety net for loved ones, start making adjustments to your number. Factor in all your assets, including the current value of retirement accounts and Social Security benefits.
Given the complexity of the calculations and projections, Brooks suggests you sit down with a financial adviser to cover all contingencies. There’s a good reason: It’s best to overestimate your needs. Why? Once you’ve purchased a policy, you can always adjust the amount of coverage you need downward. But, upward revisions typically require a new application and new coverage.
This article originally appeared in the October 2009 issue of Black Enteprise magazine.