While life insurance can be purchased for a variety of purposes, one of the most common is to maintain your family's standard of living in the event of your death. To ensure that your family is adequately protected, you need to purchase an appropriate amount of insurance. You are likely to hear various rules of thumb, such as you need insurance equal to five to seven times your annual income. Be careful of these guidelines. Since they don't take into account individual circumstances, they may leave your loved ones with an inadequate amount of insurance.
Coverage needs change over time. Young, single adults may have little reason to purchase life insurance. But once you have children, your insurance needs become greater because other family members depend on your income. Later, as children grow up and become independent, your insurance needs may decrease. However, at that point, you may find you need life insurance for other purposes.
For instance, you may want to use life insurance to help your family fund estate taxes that would be due if you died. Business owners may want to use life insurance so the business will not be sold to pay estate taxes or to provide a means for partners to buy out the heirs of a deceased partner.
The amount of insurance you need depends on your current net worth, the lifestyle you want to provide for your family, and your personal desires. To calculate the amount, take into account these considerations:
How much income will your family need every year? Make sure to consider the effects of inflation. Don't forget to include the cost of college education for your children.
Add up your assets and other sources of family income. Include any benefits your family may be entitled to under pension plans and Social Security.
Based on how long your family will need this income, your expected rate of return on the proceeds, and other factors, you can then determine how much life insurance you need.
Since your insurance needs will change over time, assess your insurance coverage periodically, especially after major events in your life. The birth of a child or a large salary increase can alter your needs drastically.
Contact your estate planning advisor for help determining how much life insurance you need.