By Peter Boys, CAFA
The Financial Coach
You’ve decided you need life insurance, but how do you determine what’s enough to protect your family or business financially? It’s a difficult question to answer, but it’s crucial to have the right amount of coverage. You want to ensure that your insurance will cover expenses and maintain a lifestyle for your beneficiaries.
Needs-Based Assessment: A needs-based assessment considers what cash and income needs your beneficiary or beneficiaries will need to sustain their current lifestyle. Cash needs include: funeral fees (last expenses), tax liabilities, legal fees, outstanding loans and mortgages, and an education fund for school-aged children. Also, you need to include your family’s current annual income and lifestyle. Within the above-mentioned cash needs, some may be categorized as permanent or temporary. Temporary cash needs are the costs that most people pay out during a set period such as a mortgage and their children’s education. On the other hand, end of life needs are costs including funeral expenses, probate fees, tax liabilities, legal fees, and an emergency fund that are required at death. It’s worth considering purchasing some amount of permanent insurance that will last your whole life to cover these permanent needs.
Application of the Needs-Based Assessment: There are various things to consider when determining the amount of insurance you need to cover your family’s immediate and ongoing needs upon your death: 1) How much savings do you have? 2) How much personal insurance do you already have? 3) Do you have insurance through a work plan? 4) What benefits are available from the government?
Take for example, Josh and Rachel have two young children, Rachel is a stay at home mom and Josh is a teacher with an income of about $60,000 after-tax. They have $50,000 in end of life needs including last expenses, outstanding loans, legal fees, and an emergency fund. Josh and Rachel have estimated that the cost of their children’s education could amount to $80,000. Additionally, they have a $275,000 mortgage and they are aiming to pay it off over the next twenty years. These necessary costs amount to $405,000. These represent cash needs.
Josh knows that he would like to support Rachel and their children financially for as long as their children are dependent. He needs to cover 50% of his income to do this. As the insurance death benefit is not taxed, and because he plans to insure the cash needs, he does not need to replace 100% of his income. Using the needs-based assessment approach, their insurance advisor helped them to determine his surviving spouse’s income needs. This was to help determine how much insurance would be required to cover any shortfall in the event of his death, which in Rachel’s case would be $25,000/year. Moreover, by factoring in inflation and a reasonable rate of return on the insurance proceeds, their advisor determined that Josh requires an additional $400,000 of coverage. With the help of a needs-based assessment and considering that they do not have any current life insurance or substantial assets, it was determined that Josh will need a policy of approximately $1 million.
Now What? Once you understand the basics of needs-based assessments, you know that having the right amount of coverage is key in protecting your family financially. Without the right coverage, your family could have trouble paying for the necessary costs such as legal fees and last expenses. If you would like to learn more about how much life insurance your family needs, speak with a trusted insurance advisor today.