It often seems like the only people that don’t buy life insurance are the ones who actually need it most. It’s depressing when I meet with a widow or widower and learn of their terrible financial position due to the loss of a loved one. I’ve had the pleasure of serving on the board of a local non-profit which provides grief support for those who’ve lost a loved one, so I have unique perspective in this area beyond just life insurance.
The financial challenges of losing a loved one for young people and older people are similar yet different. Similar because it ultimately boils down to cash flow, but the cash flow covers different needs. Younger folks have children to provide for and also tend to have more debt. But retirees can also run into trouble if they haven’t saved well enough. That’s because the smaller of their Social Security benefits will go away. If you depend on both partners’ Social Security, it can be costly and painful to lose the smaller of the two.
How to Estimate Your Life Insurance Needs
So how much insurance is needed? For most families, I use three simple factors: debt, education, and income replacement.
The debt is simple. Just add up your mortgage, credit cards, and other debts. Federal subsidized student loans are forgiven upon death, but privately funded loans will still need to be paid back. I think it is important to have all the debt retired to improve cash flow and eliminate the emotional toll debt can leave us with when someone passes away. The emotional distress on a family after a loss is hard enough.
For education, figure approximately $25,000 per year per child for in-state tuition (2017 dollars). I like to see college 100% funded through life insurance—the education of your children is the foundation of your legacy!
Income replacement is a bit misleading because I don’t really care how much you make; rather, it’s how much you spend. We need at least five years of support, but 10 years is optimal. If you have young children, don’t forget that Social Security will chip in until they’re age 18 (if you’ve earned enough credits).
As an example, let’s look at a family of four with a $300,000 mortgage and two college-bound children. The husband makes $200,000 and the wife stays at home with kids; their cost of living is $10,000 per month after taxes. This family has $300,000 in debt and are estimating $200,000 in education funding (25,000 x 4 = $100,000 per child). So the income replacement needed is $1,200,000 or $10,000 per month for ten years.
The total life insurance coverage that the husband needs is $1.7 million. Even though the wife is not working, the potential life in surance need for her would be about $500,000. Even though the household income is not tied to her; we still want to have the mortgage and education taken care of in the event of premature death.
My philosophy for life insurance coverage is to keep it simple and load up on a large amount of insurance at the lowest price possible (with a high-quality carrier). In general, most people are under-insured. Please consider your needs by following my formula illustrated above: debt, education, and income replacement. You will be surprised how inexpensive it is to fully protect your family!