For many people, buying a life insurance policy is a smart move that will protect your family and loved ones financially. What type of life insurance and how much life insurance is a question I get asked a lot and the answer is never the same.
Essentially you need enough to replace your income, cover any debts you might have and final expenses. The easiest way that is recommended to replace your income would be to take your annual salary and multiply by the number of years your youngest child is until they become legal age.
Example: You earn $50,000/year and your youngest is 5. You would need $50,000 for 13 years until child is 18, which would be $650,000.
Now that you have your income covered, we need to add any liabilities into it. This would include mortgage principal, vehicle loans, student loans, credit cards, income tax, lines of credit, etc.
Example: Mortgage balance-$200,000
The next number that should be accounted for is the final expenses. It’s hard to know exactly what this amount is, but can estimated at $15-$25,000. Funerals alone can cost a few thousand up to $20,000 depending what services are chosen. This number will change and grow with time. Capital gains should also be accounted for in the final expenses if it applies to you. If this is something that could affect you, talk to your advisor and he will guide you through it. Accounting for this at an earlier age in your life insurance policy will save you money later in life.
In summary for “how much” coverage, you would need approximately $943,500 of life insurance coverage. Your advisor would most likely round it up to an even million for anything not accounted for.
The total amount of coverage above is the easier part in finding the right life insurance for you. How long you need the coverage for can be bit trickier for some. There are a few different factors to consider. Age of dependents, length of debt payments, and final expenses.
For most people that have young children and household debts, term insurance is the most cost effective option. How term insurance works is you get to choose how long you need the coverage for and select the amount of life insurance you need.
Example: If you take out a new mortgage of $300,000 and have payments scheduled for 25 years to pay it off. You could purchase a term life insurance for 300,000 and the premium is guaranteed 25 years. This is also known as a T25 policy.
The other factors to consider in “how long” is the age of your dependent children. Providing coverage long enough to provide financial stability until they are legal age should be accounted for. Similar process to my example above for the mortgage.
Example: If youngest child is 10 years old, you would need approximately 8-10 years of coverage until they become legal age.
Lastly is the final expenses. This consists of a whole life section to your life insurance policy. It is also the more expensive part of your portfolio. This will guarantee your beneficiaries and estate will receive a payout regardless of what age you may pass away. In most cases the whole life coverage will be paid off at a certain age or a specified number of years from the policy start date. Most common are 10 year or 20 year pay options, or to age 65.
In summary each person’s life policy should be tailored specifically to them. It is also very common to have each component listed above incorporated into your life insurance portfolio in one policy.