How Much Life Insurance Do I Need?

. Often the desired goals may not be financially feasible.These issues are not only financially based; they can also be extremely emotional.

Another thought to keep in mind is that as your other assets grow, such as retirement plans and investments, your need for life insurance will decrease.

These are some of the more commonly used approaches.

• Multiple of Income – This method (also known as the “human capitalization value”) uses the approach of a multiple of your annual income—typically ranging from five to eight times your annual income. This is one of the oldest and best known methods to determine how much life insurance you need, as well as one of the easiest to use. It’s also the most frequently mentioned by financial columnists in consumer publications. While simple, this earnings-multiple method misses a range of important factors. For example, it ignores household demographics, past savings, Social Security offsets, housing expenses, taxes, etc. It also ignores expected life changes and individual preferences about sustaining the living standards of survivors. It is simply a “best guess.”
• Cover Your Debts – This entails buying only enough life insurance to cover debts such as your mortgage, student loan bills, or outstanding car notes. The issues are similar to the issues for the multiple of income approach discussed above in that it misses a whole range of factors, such as not considering any future debts or needs like child care or college education costs. This method is also too simplistic to provide any real value.
• Human Life Value Concept – The human life value concept deals with human capital. Human capital is a person’s income potential. We all have a human life value. In wrongful death litigation, human life value is measured daily in court (however, the litigation value tends to be significantly different). Insuring human life value is the primary purpose of life insurance. The human life value concept goes beyond numbers and considers the entire impact caused by the loss of a human life and the value to a person’s loved ones.
• Capital Preservation and Capital Liquidation – This method can be used in conjunction with a needs analysis approach or separately as a quick calculation, if you just want do an income replacement approach on its own. Whether you are using this method strictly on its own or in conjunction with a needs analysis, once the amount of income that needs to be replaced is determined, a decision must be made as to whether the pool of capital to provide this income will be preserved or liquidated. Capital Preservation: The capital used for income replacement is left intact and the beneficiaries live off the income it produces. Capital Liquidation: The length of time of income needs to be replaced becomes a major factor in determining the capital needed for income replacement.
• Life-Cycle Model of Consumption and Savings – The life-cycle model of consumption and savings is a new approach that is based on the life-cycle model which was developed in the 1950s and 1960s by Professor Franco Modigliani and his colleagues at Massachusetts Institute of Technology. Modigliani won the Nobel Prize in 1985 for developing the model, which built on early work by Yale economist Irving Fisher in the 1920s. This model assumes that an insured’s goals are to secure the living standards of the household and ensure comparable living standards for his or her survivors. This approach is based on the fundamental goal of saving money and having insurance—the desire to avoid major disruptions in a household’s standard of living. This approach uses advanced mathematical techniques to calculate the savings and life insurance needed to balance consumption in the present with consuming in the future and to preserve a household’s living standard for survivors. This method describes how life insurance holdings are adjusted as life insurance needs change. All economic resources, tax liabilities and benefits—Social Security retirement benefits, and survivor benefits, etc.—are taken into account in the calculation, along with family demographics, tax-deferred savings, housing plans, special expenditures, estate plans, capacity to borrow, and lifestyle preferences.
• The (Capital) Needs Analysis Method – Like the earnings-multiple method, the Capital Needs Analysis method projects the income the insured will earn between now and retirement (or later) and sometimes discounts these flows. But this procedure goes further; it calculates the net contribution of the insured to the family’s living standard by subtracting the insured’s present values of future tax payments and living expenses from his or her present earnings.The net contribution of the insured is then compared with today’s spending needs of potential survivors. Such a needs analysis incorporates factors such as mortgage payments, other household expenses and special expenditures.