Most people don’t think twice about insuring their cars and homes. They’ve worked hard to earn them, understand how much they are worth and what it would cost to replace them. Putting a price on life insurance is more challenging. How do you put a price on future earnings potential? Answering this question will help you determine both the appropriate level of coverage and the type of insurance that best serves your specific needs, and ultimately help secure your family’s future.
Considerations for Breadwinners
If you are your family’s main provider, there can be many factors to take into consideration when estimating their financial needs in the event of your death. Mortgage payments, retirement savings, funding for your children’s education and maintaining your family’s current lifestyle all need to be thought of in your planning. (For more,
Suppose you and your spouse have planned to pay off a mortgage, send your children to college and build adequate retirement savings. You are 45 years old, earn $250,000 per year and currently have $1.5 million of life insurance coverage. You plan to work 20 more years and retire at age 65. If you multiply your current earnings by 20, you get a very rough estimate of your future earnings $5 million. Is this how much life insurance you need?
The simple answer is no. There are many factors to consider when estimating the financial needs of your family if you were to die unexpectedly today. Along with the loss of income, death of a breadwinner can also eliminate routine personal expenses that add up over years. Federal and state income taxes will no longer be due, so they too must be subtracted. Additionally, you’ll have to factor in any increases in future earnings.
Some other items to consider when determining the amount of life insurance include inflation, as costs traditionally increase over time. Large unexpected medical expenses may be incurred. In addition, future medical insurance for the family may increase. Funeral costs and estate taxes should also be a part of the calculation.
Life Insurance for Your Spouse
Now what about life insurance for your spouse? If your spouse is earning, then income replacement is important. It is also important to review the life insurance needs for a stay-at-home spouse. We don’t want to forget the cost of services performed such as child care, elder care, housekeeping, carpooling, meal preparation, teacher, psychologist, etc. (For more, see: How Much Life Insurance Should You Carry?)
Studies that quantify how much it would cost to replace the functions performed by stay-at-home spouses estimate their value to exceed $100,000 per year. This translates to the importance of a review of the life insurance needs for both spouses.
Additional Coverage Benefits
Many insurance policies also have additional benefits, or riders, that should be considered. An example of one of these additional benefits is a waiver of premium rider, which indicates that you don’t have to pay premiums during your working years if you become totally disabled and cannot work.
Another is the long-term care rider, which allows you to accelerate the payout from a life insurance policy to pay for long-term care benefits once qualifying requirements are met. Although adding benefits increases the cost of coverage, these and other riders could be very beneficial in the right circumstances.
It is important to determine both the appropriate level of coverage and the type of insurance that best serves your specific needs. A thorough review of all these considerations should also be conducted every few years to determine if changes should be made.