Like auto
insurance coverage, it is sometimes difficult to see the true value
of life insurance coverage until you actually need it. In the
meantime, the only way you will feel comfortable with your life
insurance policy is if you understand, and agree with, the reasons
you bought it in the first place.
There are many reasons for an individual to own life insurance
coverage. Perhaps the most compelling reason is to purchase a
death benefit which will provide for the financial needs of their
survivors.
Determining how much life insurance coverage you need is a four
step process:
- Determine total short term needs in the event of your untimely
death
- Determine total long term needs in the event of your untimely death
- Determine total resources available to family members
- Provide insurance coverage for any remaining shortfall
Determining Your Total Short Term Needs
Short term needs are financial obligations and/or expenses
arising within six months of death. Examples of short term
needs include expenses you pay now such as:
- loan balances (automobile loans, etc)
- outstanding credit balances (credit cards, revolving lines of
credit, etc)
- mortgages (first mortgage, second mortgage, equity loans)
Add to these current expenses any death-related expenses which
must be paid in the short term:
- funeral expenses
- final medical costs
- estate settlement costs
- estate taxes due
- charitable bequests you would like to make at death
And if you don't already have one, your survivors should be left
with a liquid emergency fund sufficient to get them through any
unexpected financial needs, perhaps six months worth of living
expenses.
Determining Your Total Long Term Needs
In addition to covering your survivors' short term needs, some
level of monthly income will be needed to maintain their standard of
living and meet financial goals you have made together. These
long term income needs include:
- a future income stream to cover standard of living items (we recommend that you identify several time
periods with unique needs such as while kids are in home, when
kids are gone, and your spouse's retirement years.)
- college expenses that you would like to cover for your
dependents
- elderly care expenses you plan on contributing for relatives
- monetary support for a disabled dependent
- mortgages (first mortgage, second mortgage, equity loans)
- child care costs if your spouse will work after your death
The value of these future obligations is discounted back to
present value amounts. This gives us a single dollar amount
which, if invested, could provide funds for all of your long term
goals.
Calculating Your Total Available Resources
At this point, we have a pretty good idea of what your total cash
need would be in the event of your untimely death. With
any luck, you have already begun to set money aside to cover some of
these costs, and the government has a plan to help you as
well.
- Estimated earned income of your survivor(s)
- Survivor Social Security benefit (continues while you have
children under the age of 17)
- Retirement Social Security benefit (begins approximately when
your spouse turns 65)
- Survivor benefits from your pension plan
The value of these future resources is discounted back to present
value amounts. This gives us a single dollar amount which we
can use to offset your total needs.
Providing Funds To Cover A Shortfall
When we compare our total needs to our total resources, most of
us will find a shortfall. A shortfall situation means that our
survivors will be left with the choice of either finding additional
resources that we have not been able to identify, or do without many
of the financial needs that you hope to cover.
Life insurance is uniquely suited for covering such a
shortfall. It is a means of sharing the financial risk of
premature death with many, many others who have similar
concerns.
You pay a relatively small premium to an insurance company in exchange for
their promise to pay your beneficiaries a specified
death benefit in the event of your death. A financial need
that arises from your death can be eliminated by a financial
resource
that is created upon your death.
Factors To Consider When Selecting Life Insurance
In an ideal world, we would each carry sufficient life insurance
to continue to provide a lifestyle for our survivors similar to what
they enjoy now, with us here. We cannot always afford to fully
cover our survivor needs, particularly in our early years.
However, life insurance comes in many shapes and sizes. By
carefully considering the type and amount of life insurance that
best meets your needs you can ensure that you have provided for your
family's monetary needs, even if you are not here to do the
providing.
