When we create a comprehensive financial plan for a client, our objective is to accomplish three things: protect you from risk, grow your assets, and establish strategies that help you effectively accomplish your long-term goals. We start by protecting what you already have so you can focus your further efforts on growth without fear of the unknown. Life insurance is one of the primary ways we establish your protection plan so you can be confident about the future.
Life insurance is one of several “bricks” in your financial foundation, but it’s an important one—it ensures your family and other responsibilities are cared for if you’re unable to do so. There are some people who don’t need it, of course—like a widow or widower whose debts are paid and children are grown—but if you have a substantial estate, are part-owner of a business, or have anyone relying on you financially, you should consider life insurance as a foundational piece of your financial plan.
So how do you determine just how much life insurance you need? The right amount is different for everybody, which is why it’s important to evaluate your goals for life insurance—what do you need this money to accomplish when you’re gone? This is our main objective when discussing your life insurance goals—we want to help you understand not just if or why you need life insurance, but what you need it for, and for how long.
There are three primary factors we consider during a Life Insurance Needs Analysis:
Outstanding Debts
Legacy and Inheritance
Income Replacement
The first factor is pretty simple—if you had to write a check to pay off all of your outstanding debts right now, how much money would that be? If you owe $300k on your house and another $50k in other debts, that makes $350k you need for what we call “Part I” of your life insurance needs.
Most parents want to help their kids financially jumpstart their adult lives, but few parents take time to ask themselves what that looks like to them. When you picture giving your child a leg up as a young adult, what does that mean to you? Do you want to pay for their college, give them a down-payment for a house, or provide some cash for them to start their own business? Either way, you need to determine exactly how much money that requires. For this example, let’s say you have two kids, and you decide you want to leave each of them $100k for higher education—that makes $200k for Part II of your life insurance needs.
Believe it or not, this is the aspect most people overlook when they’re planning. Or, at the very least, they don’t consider what it means to replace their income adequately according to their goals. The first thing you should consider is how long you want to supplement your family’s income if you were to pass away unexpectedly. Let’s say you want to make sure they’re covered for at least ten years. If you earn $60k a year, that’s $600k to cover Part III of your life insurance needs. (Of course, if you plan to be the sole provider for your family for an indefinite amount of time, that number would increase relative to the number of years you planned to support your family.)
To complete your life insurance needs analysis, we add the three factors together:
$350k in debts +
$200k for your kids +
$600k to replace your income for ten years =
A $1.2 million life insurance policy (roughly).
Each person’s needs and goals are different, so your ideal amount depends on your circumstances and how you want to support your family’s future (or the future of your business). Without assessing these three factors, it will be difficult to determine the right number for yourself.
To get a better idea of what this calculation looks like in application, I’ll use myself as an example.
I have a $5 million life insurance policy on myself. Typically, when I first mention this to clients, they think it’s a ridiculous amount of insurance for one person—but before you close your browser, hear me out—there’s a reason for this number. Here’s how I determined that this was what I needed for my family:
My wife is a chemical engineer. Since we had our two girls, she decided to stay home with the kids. We both want her to be able to do this for as long as our girls are home, and that’s at least for the next 20 years or so. If I were to pass away unexpectedly, I would need money to cover both our current debts and the income I’m making now.
But consider this—if I purchased life insurance according to that calculation alone, then after 20 years, my wife would be 52, and that money would be gone. At that point, she would have to go back to work—in her fifties, after being out of the workforce for 20 years. Despite her credentials and experience, she wouldn’t get the kind of job she’d once been highly qualified for. More to the point, that isn’t what either of us want for her future. The other thing to consider is that she would then have to start saving for her own retirement at age 52, which is never ideal. So, if I only considered our debts and replacing my income for the next 20 years (and not how I want to bless my kids or prepare for our retirement), I wouldn’t accomplish our goals with that kind of life insurance policy.
If I really want to give my wife and kids the life we planned, I need to consider every factor that affects my family’s finances in the long-term—paying down debts, providing income for the next 60 plus years (not just 20 or 30), and the money I want to leave for my girls’ college funds, weddings, or other life adventures.
When you look at it this way, $5 million distributed over the course of three lifetimes (my wife and two daughters) isn’t that much money.
Of course, not everybody needs or wants that much life insurance. That’s why it’s important to consider precisely why you and your family need this money. Once you analyze the details and consider how the situation could play out, you’ll have a better idea of how much life insurance is right for you. It’s important to note: the amount of life insurance you need is much more important than the type (term, whole, or universal). When it comes time to deliver a death claim, no one cares what kind of policy you have; it’s just important that the money is there for the people you care about.
If you’d like to learn more about calculating your life insurance needs or the type of insurance that would best support your goals, we’d love to talk with you. Send us an email or give us a call at (850) 542-4803 to see how we can help.
125 W. Romana Street, Suite 720
Pensacola, FL 32502
Phone: (850) 542-4803