How Much Life Insurance Do You Need?

The Physician’s Life Insurance Primer Series: Right-sizing your policy can offer the real peace-of-mind that insurance is meant to provide.

Anyone with a family to protect understands the critical role life insurance plays in their financial plan. However, in determining the actual amount of coverage to provide essential protection needs, many people tend to adhere to simplistic rules-of-thumb, such as a “multiple of income,” which may leave them wondering if they own too much or too little coverage. That’s not exactly the “peace-of-mind” we hope for when buying life insurance.  We will review steps you can take to achieve the peace that life insurance promises.
With your family’s financial future at stake, wouldn’t it be better for all concerned to simply clarify and quantify your family’s actual needs? While it does require a bit more time, some frank discussion with family members, and some number crunching, it will provide the assurance everyone needs that their financial lives can be secure.

5-Step Process for Estimating Your Life Insurance Needs

Determining your actual life insurance needs is best done with your personal financial advisor who can help you evaluate all aspects of your situation. A little preparation on your part can help the discussion be most fruitful. Start by thinking through and documenting your estimated needs following a simple five-step process:

1.  Identify and clarify your goals and needs

It is critically important to determine, as a family, what is it you want to protect. Is it important that your family be able to maintain their current lifestyle? Is it important that your children be able to obtain a college education? These and other family goals need to be thoughtfully considered.

2. Quantify the actual financial need

Immediate cash needs are obligations that need to be met by the surviving family, including

  • Outstanding debt (mortgage, student loans, credit cards)
  • Final expenses, including funeral costs, estate settlement costs, medical expenses
  • Future goals such as a college education for the children should be pre-funded

Final expenses are an estimate but they shouldn’t be understated. Some financial planners suggest a figure as high as $50,000 to provide a cushion for unexpected expenses.
College funding or other family goals should be estimated and adjusted for inflation to cover the projected cost at time of need. Base the estimate on a present value of what you would expect to pay today factored by a rate of inflation up until the time the funds are needed.
Income replacement needs should be determined based on the amount of lost income and the ability of surviving family members to replace all or a portion of it. Quantifying the income replacement need can be a little more complicated; however, the most important thing is to use realistic assumptions. It should be based on the family’s actual budget (assuming debt obligations and future goals are paid). The budget should be adjusted for post-dependency years when the children are on their own. Most importantly, a realistic assumption has to be made as to the ability of the surviving spouse to replace any portion of the lost income throughout his or her lifetime. For the dependency years and retirement, you can apply an estimated Social Security benefit to offset the income replacement need; however, a more conservative approach would be to exclude it from your calculation.
Determining the capital need for income replacement is obviously more complex. The critical point of this explanation is to recognize that, when you are determining how much capital will be needed to replace your income, there are a lot of factors to consider, which a simple “multiple of income” formula cannot account for. Your advisor can lead you through that evaluation.

3.  Determine how much existing capital or insurance is available

Take an inventory of your liquid assets, retirement plans and existing life insurance. If you own a business or real property, you would need to determine whether these assets are to be made available (as well as the practicality of having to liquidate them).

4.  Determine the amount of your capital need

Simply subtract your capital available from your capital needs (immediate cash needs plus income replacement needs) to arrive at your net capital need. That is how much life insurance you need.

5.  Review your needs with a registered insurance advisor.

Life insurance is too important to rely upon guesses or simple formulas to determine the amount of coverage needed to fully protect your family. There are many factors and variables that go into determining how much life insurance is needed in any particular situation. Nothing short of a complete capital needs analysis will provide an accurate assessment of your actual life insurance need.
It’s strongly recommended that you work with a qualified, objective life insurance professional that has access to a wide range of solutions from the top life insurance carriers. Using this process, you will gather much of the documentation and information your advisor needs to help you make wise choices, you will also feel more confident in your choice having a better understanding of how to evaluate your needs.
Our team would be happy to review your analysis and help you select a policy that meets your needs.  It is as easy as completing our simple quote request form.
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Read other articles in The Physician’s Life Insurance Primer series:

Types of Life Insurance for Physicians

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