How easy would it be for a life insurance agent to say that your needs in case you die is about 750,000$? What would you say then? “Are you sure? Isn’t this coverage a little bit too high for my family, for my budget?” “Absolutely not, you don’t want your family to be in financial trouble if you die, do you?”
Hmmm this is the kind of situation you don’t want to live. Having the right life insurance protection is important and of course you want to leave a pretty big amount of money to your spouse and kids if you were to pass away. But the real deal here is to be properly protected, paying the right (and fair) premium and putting the rest of your money into investing so you can fulfill all your responsibilities: if you die too soon or if you are strong enough to live too long and go through your retirement (and you have all the chances on your side for this one).
So, there are 3 major parts with which you want to work to calculate your life insurance needs:
2- Income replacement
3- Short term debts and education costs
Picture this: a financial planner is building strategies for you to succeed long term based on 1 or 2 incomes in the household. Debt elimination, taxes, retirement and some free time are the bases of what he looks with you. Everything is based on 1 or 2 incomes. If one person is to die, how in the word is the surviving person is supposed to continue all the strategies to pay off the debts, putting money aside for future projects and retirement?
The first component of the coverage you need is the mortgage you now have or the one you will have real soon (meaning in couple of months… not when we buy our dream-house in 15 years!). If you still have a balance on your mortgage of 245,000$, making sure this liability disappears after you die is really important. It is probably the biggest financial burden we all have in common and you don’t want to leave it to your spouse’s shoulder alone if you die.
There are people who are living together but are committed to separate everything in half. Half the mortgage, half the grocery, etc. Do you know people like this? In that case, you could consider putting in your calculations half of the amount for your protection.
If you living in an apartment, you can easily make the same procedures but instead of using the whole mortgage amount, you use the actual value of your monthly rent. There are so many free online financial calculators where you can input your monthly rent, a number of years (let’s say 25) and using a 5% rate of return. What this calculation will give you is a big lump sum you would have today if your spouse were to die. For example, a 1,000$ monthly rent, for 25 years at a 5% rate of return would mean having today near 175,000$. By receiving this amount, you could put it in an investment generating 5% (like an income fund) and you could withdraw 1,000$ each month to pay your rent for the next 25 years. So having a roof and securing your family is done.
After having taken care of you biggest debt, we now have to consider the income replacement. You have to be honest and say: if my spouse were to die tomorrow, how much money would I need on top of what I already earn to keep the quality of life of my family at the same level? I said to be honest, remember? For example, if your spouse is making 2,000$ net income a month, don’t come up and say: I need 4,000$ because I want to retire the day after she dies! And also don’t forget you already have a roof (a house paid for or an apartment paid for the next 25 years), so concentrate only on your monthly fees. Usually, 1,000$ to 2,000$ for most people is perfect. Take into account that the proceeds received from life insurance is tax-free, i.e., it’s net in your pocket. Also use a period covering the gap between your youngest child and 25 years-old. Why 25? Because your kids will probably leave the house around 25 and that by having a job, you can easily subsist to your needs by yourself, not needing extra money to live with (because the more money you want to receive, the bigger you pay the premium).
With the monthly amount in your head, you go through the same procedures to calculate the actual value of that monthly cash flow. For example: if you consider that having 1,500$ per month is going to cover your monthly fees (don’t forget as you kids grow up, their demands also “grow up”) and your youngest child is 8 years-old, you can calculate the actual value using a 17 year period and the same 5% rate of return. You will end up with nearly 207,000$. Again, with this amount in an investment generating 5% (like an income fund), you can withdraw 1,500$/month for the next 17 years to use to keep your quality of life intact.
The last thing to look for is to take into account your short term debts, like credit cards, line of credits, car loans, student loans, etc., and the cost of your kids’ education. It is important to leave a financial situation as clear of debts and financial worries as possible to your spouse because they already have to deal with the emotional loss of a loved one. You don’t want to put extra pressure having to deal with payments now. And they may not even be the one that is used to make the payments and they don’t know how it works!
So let’s make the total now. You have 245,000$ for your mortgage (or 175,000$ for your rent), 207,000$ for income replacement and let’s say 50,000$ to cover for car loans and credit cards. You need 502,000$ of total protection, not 750,000$! By receiving this amount, your spouse will be able to take 245,000$ to pay off the mortgage, 50,000$ to pay off the short term debts AND withdraw 1,500$/month for 17 years to keep your quality of life. Is your spouse in good financial shape if you die? You bet! Now you just need to properly build your protection, you can read Term Life Insurance, Whole Life Insurance and Universal Life Insurance to better know how to build your life insurance policy.