The original method: Adding up the money needed

A calculation life insurance professionals have used for many years attempts to tally up the money needed for all present and future obligations the surviving family will have, in 4 “buckets”:

+Outstanding debts and funeral / estate expenses: We will assume $15,000 needed for the funeral and estate settlement, $15,000 for an outstanding car loan, and $5,000 in student loan debt= $35,000 total.

+Your remaining mortgage loan owed: Eliminating this large monthly payment, making the home “free and clear” can be a great relief for a surviving spouse. The Baines family currently owes $250,000.

+Expected higher education costs for children: The Baines have two small children they hope will take advantage of college or university in North Carolina. We will estimate $75k per child needed = $150,000.

+And the deceased spouse’s income, to provide for the family for a certain number of years into the future. Mr. Baines’ income is $87,500 annually x 15 years = $1,312,500.

= a Life Insurance benefit need of $1,747,500.

An updated method: Replicating an income stream

A weakness of the original method is that we cannot predict the future! A couple determining future costs in the early 2000s would not have budgeted for cell phone costs, nor know the college costs inflation rate.

As each of us earns our income, funding our family budget, we learn to adapt. New costs enter our budget, and others end. We find a way to make it work.

So an updated way of calculating a life insurance benefit is to see it as an amount of money that could be invested to replicate the deceased family member’s income well into the future.

Mr. Baines earns $87,500 annually. If he died today, Mrs. Baines and her children would lose that income.

But a $1,250,000 Life Insurance benefit, invested and earning 7% annually, would produce an annual interest income of $87,500! This Life Insurance benefit would replicate Mr. Baines’ income indefinitely. And if Mrs. Baines needed extra money for a large expense, the invested benefit would be available.

Mr. Baines could add in an extra amount to pay off the mortgage, moving the benefit to $1,500,000.

Don’t want to do the math? Here is a “cheat code”

Calculating this benefit is a lot of math. There is also a pressure to “get it right.” These factors lead many to people researching Life Insurance to buy to “shut down.” In other words, it is a great excuse to put buying Life Insurance aside.

If you feel this way, here is a cheat code…take your annual income and multiply it by the number 17.

In the Baines family’s example, Mr. Baines earns $87,500 annually x 17 = $1,487500.

Very close to our two prior calculations of Life Insurance need!

And note…any Life Insurance benefit is better than none. If you calculate a benefit need, then request quotes of life insurance policies, but are afraid your current family budget cannot absorb the premium costs, that is OK. Choose the benefit you can now, then choose more benefit in the future.