First, how much is needed to cover a person’s obligations at the time of death? To determine that amount one needs to consider medical bills, funeral expenses, outstanding debt, and mortgages. Often there are costs that many forget like the costs to settle the estate which includes attorneys and accountants who all will expect to be paid for their services, so your beneficiaries can take what remains and hopefully maximize what remains within the laws of the probate code. Since there are many unknowns you simply need to do your best to estimate those costs given the information you have now. Certainly, the average cost of a funeral and the average cost to settle an estate are readily available.
Rest assured, there will be unknown and unexpected costs and bills that arise, but they are exactly that – unexpected and unknown, and thus there is nothing you can do about it except maybe factor in a safety margin to an extent that you feel comfortable. Again, you are seeking peace of mind knowing there is enought to take care of your loved ones. Let go of that which is completely out of your control but put a safety cushion in just in case if that make you feel better.
Second, how much will be needed to support the household after you are gone? This largely takes into account the income stream that you would have otherwise brought into the household over a period of time. Certainly, it would not be reasonable to think that period of time would run into perpetuity. Although life insurance is often used as a wealth building vehicle, we are not dealing with that question here and that will be left for another day. Here, however, we are considering that which reasonably would be expected to allow the family to comfortably sustain their household while matters readjust to account for the income that has been lost. That may be perhaps a period of time until all the children reach the age of majority or until one’s spouse is ready to retire.
Whatever that period of time may be, you must also remember that a dollar tomorrow is not worth the same amount as a dollar is today. Thus to determine what is needed you will have to consider the time value of money. If you seek to be exact, some mathematics will be involved. Or, just add 10% for every year until your expected age of death using any actuarial table. Note, most spread sheets have built in financial function that can make those calculations for you. (click here to go to our Life Insurance Tools, where we have spreadsheets and other widgets to help in you in you quest for Life Insurance information.)
An alternative approach, is the notion that you just want your family to have a lot of money and they can figure out what to do with it. That may be $500,000, $750,000, $1,000,000, or more. This is a very technical approach that those in the business say “what does your gut tell you?” Which takes into account that your gut is usually right. However, keep in mind that what your gut tells you may not be what your wallet says you can afford. Even though you may want your family to inherit a multi-million dollar insurance policy, you may suffer in the short run as the premiums chew up your disposable income. You need to put a line item in your budget that includes the premium to be paid each month and for each year and most have a budget that figures what they pay out of each paycheck. That life insurance line item needs to be at the top of the budget with those important matters of necessity such as mortgage, utilities, food, and college. You may have to adjust those more expendable items at the bottom of the budget.
However that happens, make sure the premiums fit within your budget so that you maximize the amount of the policy with the dollars you have available. That’s why you shop for insurance to make sure you get the biggest bang for your buck. You also have to keep in mind that you need to pay that premium for many years, which may be a daunting thought at the outset. However, we have all experienced a payment that at one time seemed to be somewhat expensive, seem so much more affordable years later. Think about the mortgage you had 20 years ago. It seems like a drop in the bucket compared to your current house payment. This is just another effect of the time value of money.
With life insurance, the premium needs to be affordable today so that years later that payment will seem, and actually be, easier as you pay the same amount with dollars that are worth less. Also, you want to make sure you can continue to support the policy, as there is nothing worse than paying for many years and then allowing the policy to lapse, which could happen right when your family may need that policy – ouch. So despite whatever calculations are made, or what your gut tells you, the perect life insurance policy for you may be that which you can afford. In fact, getting what you can afford is the most responsible approach you can take. Even if its not that multi-million dollar payout, you are taking care of the ones you love and doing the best you can with what you have.