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Financial Planning for June, 2010

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Life Insurance - How much is enough?

Do you have a family that depends on you? If so, you probably need life insurance. But exactly how much do you need? The answer depends on numerous factors, but primarily this is based on your age. Let's discuss what you should consider in determining your life insurance strategy.

The purpose of life insurance is to provide assets that along with the income generated will allow your family to:

  1. Meet estate obligations, including taxes and final expenses (funeral, medical)
  2. Meet current debt obligations (credit cards, short-term loans)
  3. Pay ongoing debt service obligations (home mortgage)
  4. Provide for education expenses for your children
  5. Maintain your family's current lifestyle

This sounds simple until you start to count the real costs of your style of life. If you are married and have children, aside from the cash contribution of your salary and your spouse's salary, there are numerous functions you both serve that sometimes get left out. For example, what is the value of the childcare services your spouse provides? Did you ever stop to think about the cost of preparing meals on a daily basis?  Some estimates put the value of the primary homemaker at nearly $100,000. That figure is debatable, but the point is that your family will lose far more than you and your salary if you die prematurely. Take that into account in determining the amount of insurance you need.

Let's look at individual items.

Current annual required income would look a lot like your budget. Account for everything you spend. Include groceries, clothing, childcare, entertainment, etc. You might think you should adjust your current budget to account for the fact there will be one less mouth to feed, but that might not be wise. Your family will incur expenses that it presently does not have.

Consider debts and final expenses, except for the home mortgage. Do you have short-term debt or revolving debt such as credit card balances or auto loans? You will want to pay these off to minimize the future economic burden on your family. Life insurance proceeds should be enough to include the elimination of these debts. Don't forget that you might incur significant medical bills and funeral expenses. Provide enough insurance to meet these needs as well as any estate taxes.

Educational costs for your children will be expensive. With the cost of post-secondary education on the rise, your insurance proceeds should be enough to establish an educational fund for your children.

What about any special needs? Will you have to provide assets for anyone in the family with special needs who cannot provide for themselves in the future? How much will be necessary to support one or more such dependents? Once you have established your family's needs, you can reduce these expected amounts by assets already owned.

Take into account your savings and investments. What investments and savings do you currently have? Are they available or will they be available for investment to help offset future expenses?

Retirement assets must be looked at in a different light.  Account for these separately from other investments because their availability for current use could be severely limited.

Do you have other life insurance coverage? If you are adding to insurance, make sure you account for what you already have in place.

Look at your spouse's income. If your spouse works, take into account his or her take-home pay.

And then there are Social Security Survivor Benefits. Your spouse or children will receive benefits as your survivor.

Once you have determined your needs and resources, the only thing left to do is try to estimate inflation and future rates of return. Fortunately, the Internet has numerous calculators to assist in coming up with your required level of insurance. One such calculator can be found at Lifehappens.org. This is by no means the only calculator on the web and its use in this article is not intended as an endorsement. Let's take a look at its suggested level of insurance based on the following assumptions:

  • Your spouse is 35.
  • You have two children, ages 5 and 6.
  • Your current salary is $75,000 and your spouse’s is $75,000. Your combined net after tax income is $100,000. You spend $100,000 each year for yours and your children’s maintenance, including health insurance.
  • Your retirement savings is $150,000, but you have no other savings.
  • Neither of you have any other insurance.
  • You estimate your final expenses to be $15,000 and you have debt outstanding of $25,000 besides your home mortgage. Your home mortgage is $200,000.
  • You estimate the cost of a four-year college education in today’s dollars will be $100,000 for each child.

According to both Forbes and Lifehappens.org, you require approximately $1.1 million in insurance to meet your family's needs. Assuming your spouse and children receive about $36,000 in Social Security Survivor's Benefits, you would then need approximately $700,000. But remember, the full $36,000 will only be paid until the youngest child turns 16.

Every person's situation is unique and your needs today do not necessarily equal those in your future. This article is intended only to help you consider this subject and understand that a periodic review of your financial situation is important if you are to provide adequately for your family. If you haven’t reviewed your insurance coverage recently, give us a call. Let's talk about how you might better secure your family's future if you are ever out of the picture.

Have a terrific month.

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