Calculating Life Insurance Needs

There are two primary parts to determining one’s life insurance needs. One is regarding the amount of Life insurance and the other is regarding the duration of time for which the Life insurance will be needed. We use a simplified 4–step methodology to assist you in conceptualizing your Life insurance needs.

Current Situation
As a starting point, you should consider your current asset situation. In other words, if you were to die today, what assets would be left to your family? This should include: Savings, IRAs, Retirement Plans, Life Insurance, net value of business interest, Real Estate or Property Value, etc. (You may not want to include equity in your primary home, since your spouse and child may continue to live there.)

Setting Financial Goals
The next step should be to determine the financial goals and needs you and your family have. How much money will be needed to accomplish these needs and goals? This will often include things like: Paying the balance of a mortgage, Funding a child's education, Providing an income stream for a surviving spouse and family, Funding for final expenses, Funding to clear remaining debt, Funding to pay estate tax liabilities, Funding to buy–out a business interest, etc.

Filling the Gap
This is where you compare the value of your existing assets and the amount of money required to accomplish the financial needs and goals you have set. If your current assets are equal to or greater than the amount of money required, you may not have a need for life insurance, other than potential estate tax liabilities. However, if the value of your current assets falls short of the amount of assets needed, then Life insurance can be a simple and inexpensive way of creating the additional money that is needed.

Planning for the Future
So now you know what your Life insurance needs are, but we have not figured out how long it is needed for. The last step of the process involves figuring out how long your Life insurance needs will exist. Should you be considering Term Life insurance or Permanent Life insurance? In order to determine length of time, you should periodically revisit the financial goals you established. In revisiting the goals you are trying to accomplish, you should be able to make a decision on whether your Life insurance needs are only for a specific period of time, in which case Term Life insurance may be sufficient; or if your Life insurance needs are indefinite, Permanent Life insurance may better serve you.

Maintaining an Income Stream

The following methodology can help assess how much coverage is needed to maintain a desired income stream:

Assume that $1,000,000 of assets is invested in a moderate portfolio that averages a 9% rate of return.

After deducting taxes, the net rate of return for this investment is about 6 or 7%.

If you would like to preserve the purchasing power of these funds then you will need to reinvest about 3 or 4% to try keeping level with inflation.

In following this example, you can assume that for every $1,000,000 of investable assets, $30–40,000 of after–tax, annual income can be created while still maintaining principle. If you want to be more conservative, you can begin with a rate of return you believe is more achievable than 9%.