Do I Have Enough Life Insurance?
David LeNeveu
There is no doubt that every segment of the population can benefit from life insurance. Whether they are a young mother or father with a mortgage and two children or an older couple looking to preserve their wealth, there is a need for life insurance. But how much life insurance does each individual situation require?
My Job Provides a Life Insurance Policy So I’m Covered, Right?
Many families have a life insurance policy included in their work benefits and automatically assume they are adequately covered. Unfortunately, this is usually not the case. Most work policies will offer a death benefit of 1 or 2x the amount of their current salary. As I will explain, this amount of coverage is normally not enough. Some families also don’t realize that many life insurance policies will expire as soon as they leave their job. These policies are usually not transferable or, if they are, they are usually much more expensive than a separate personal policy. In the end, most families who rely on life insurance through their work are not adequately covered and they end up having to apply for a personal policy that will give them the coverage they need.
So How Much Life Insurance Do I Need?
Each and every individual and family situation is unique and should be treated as thus. It is strongly recommended that each family and individual seek a licensed professional to assess their specific needs. In the following example I will assess a fictional Canadian family consisting of a married father and mother with two young children under the age of 5. This assessment should not be construed as a recommendation or assessment for anyone’s personal or family needs.
Debt
At the minimum, a life insurance policy should help pay off all of your debt (mortgage, car loan, credit cards, etc) and pay for your final expenses (funeral costs, etc). These numbers can add up quickly. In our example the family has the following amount of debt:
Mortgage: $230,000
Car Loan: $7500
Credit Cards: $2500
Final Expenses: $10,000
Total Debt: $250,000
We already need a $250,000 policy and we have just covered the bare minimum.
Future Obligations
Most families would agree that they would like to be able to pay for their children’s post secondary education, especially if they were not around to see them graduate. It’s not hard to imagine that the cost of two children going to university could range anywhere between $50,000 and $100,000.
Income Replacement
The final, most important, and largest determinant of a life insurance policy is the replacement of income in the event of the loss of a wage earner in the family. For a family to maintain a similar lifestyle after the loss of a wage earner the life insurance policy must be large enough to replace the lost income. It is normally advised that the death benefit principle be invested in a modest and safe investment and not drawn upon. This will help to ensure a steady stream of income for the family in the time it is needed most.
A family with a modest yearly income of $50,000 may need a $500,000 life insurance policy just to replace the lost income. This would assume an average return of 10% on the $500,000 lump sum benefit and would give the family $50,000 a year to replace the lost income. If we were to use a more conservative 8% return on the investment, the death benefit would have to be even higher ($625,000) to replace the lost income. *Note: The average rates of returns provided in this example are assumptions and are in no way guaranteed.*
The Final Tally
After adding up our debt ($250,000), school costs ($50,000), and the lost income ($500,000), we find that the family needs a life insurance policy of $800,000. This may be significantly more than what the family is receiving through a life insurance policy at work (1 or 2x their $50,000 salary). Even if we were to cut the required death benefit in half, to $400,000, the family would still be well short of their insurance needs.
I would be remiss if I did not also advise each family to consider the effect of the loss of a stay at home mother or father. In order for the sole income earner to continue working they must ensure that the children are taken care of while they are at work. Child care costs of only $1200 a month for 15 years would add up to $216,000. It would be well worth the time and money to make sure both parents are covered in the event of a tragedy.
If you have any questions or concerns or if you would like a free evaluation of your individual insurance needs, please don’t hesitate to call or email me.
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A downloadable version of this article can be found here.