Life insurance provides a benefit to your family members or other designated beneficiaries upon your death. In addition, if you have debts, such as a mortgage or credit card, life insurance can help cover those obligations and avoid hardship for those who depend on the income you provide. But what about expenses that arise during your lifetime? Having enough life insurance while you're still alive can help protect your family's lifestyle in the event of disability or other unfortunate circumstances.
LIFE INSURANCE RULE-OF-THUMB
The first step is to speak with a financial advisor about your goals and situation. They can help you understand what insurance options work best for you, based on where you are in life and how much coverage you need. A good rule of thumb is to look at your current savings and expenses, figure out how much of your monthly income you would need to replace if another tragedy occurred, then multiply that number by the number of years you'd like coverage. For example, if you know it would take about $1,500 per month to replace your living expenses in case of disability, and you'd like the policy to cover you for 20 years, that's $30,000 per year x 20 years = $600,000 in coverage. Remember, no rule-of-thumb takes the place of personalized guidance from a licensed financial advisor.
THE DIME METHOD
Another way to determine how much insurance you may need is the DIME method, which stands for "Dwelling, Income, Medical Expenses, and Education." With this method, you add up the value of your home equity, monthly income, and funds set aside for medical expenses and education, then compare that to your total debts. Here's how it works:
- Dwelling: If a tragedy were to occur, how would that affect your ability to pay your mortgage or other housing costs? For example, if your family could only cover the mortgage payment with your income alone, adding life insurance into that equation might be worth considering.
- Income: If you were unable to work due to illness or injury, how much income would your household lose? Would you have enough savings to continue meeting regular monthly expenses?
- Medical Expenses: How much money do you have saved for future medical expenses? If you faced a serious disability, how much would it cost your family to cover your living and medical expenses?
- Education: How much money has been set aside for each child's college education – the earlier their age, the more important this coverage is.
When adding up these four Dime amounts, the DIME method instructs you to consider that total as a percentage of your debts. If the total is equal to or greater than 100%, then you have enough coverage – possibly more than you need – and it may be a good time to reconsider what your needs are.
Regardless of which calculation you use, for most people, the goal is to make sure their family has enough financial resources to comfortably live if tragedy were to occur. So, when considering life insurance, look at your current savings and monthly expenses, consider how much you would need to replace after a tragedy, and calculate the best way to get there while protecting your family's future.
PERSONAL ASPECTS
Taking out term life insurance is just the first step. You also want to think about how much life insurance to take out, what you will be covered for and when it should begin. There are several factors to consider when determining how much life insurance you should take out, such as your income and the financial obligations of those who depend on it. Your family members' needs will also change as they grow up or start a career. Ongoing discussions with your financial adviser can help you set appropriate levels.
- DEPENDENTS
Your life insurance coverage may provide your family with the financial resources they need to maintain their lifestyle, such as covering your mortgage payments and keeping up with other expenses. Some policies also cover outstanding debts. If you have children, you'll want to ensure that they're financially taken care of if tragedy strikes. You can use term policies or permanent coverage as a way to help provide financial security for your heirs.
- COLLEGE EXPENSES
If you have young children, term life insurance coverage may be a good option as it is inexpensive. Conversely, if your children are older, you'll want to consider permanent life insurance policies that can provide them with sufficient funds for their education. An added benefit of permanent coverage is that it will remain in force after they graduate from college.
- FUNERAL EXPENSES
Funeral expenses can be a significant expense, so you'll want to consider whether your plan can provide sufficient funds. Some policies will cover burial costs as well as funeral expenses if the event occurs unexpectedly. Permanent coverage is usually more than adequate for this purpose. You may also want to buy additional coverage to ensure that your family has resources after other outstanding debts and taxes are paid. If you're uncertain, discuss your options with a qualified financial adviser.
- HEALTH AND AGE
Generally speaking, the older you are and the more health problems you have, the more expensive your insurance policy is. However, there is no cut-and-dried way to determine how much coverage is enough as there are so many external factors involved, such as changes in your job or living arrangements. Your insurance agent or financial adviser should be able to provide you with a quote based on your situation.
- AFFORDABILITY
One of the main reasons people don't purchase sufficient coverage is that it's simply unaffordable. If you're in this situation, try to prioritize your spending and look for areas where you can cut back on expenses in order to make room for life insurance premiums. For instance, you might downgrade your home or car or cancel certain memberships. Many people find that if they split the cost with their spouse, it's more affordable. You also may want to look at what you can afford to spend on coverage.
- DAILY EXPENSES
When purchasing life insurance, it's essential to determine what type of coverage you can afford. You can work with your financial adviser or insurer to review different options that meet your personal needs. Regardless of the amount you choose, remember that adding an additional individual increase the cost significantly You'll need to consider how much insurance you will need on an ongoing basis. If you're the sole breadwinner in your family, make sure that your coverage will be sufficient to cover expenses such as mortgage payments and other living costs.
When determining your level of risk for the future, be sure that it reflects both current and ongoing needs. For this reason, it's essential that you work closely with a qualified financial adviser when making decisions about the type of coverage that will best suit your lifestyle. Life insurance is designed to help provide your family with financial resources if you're unable to work due to illness or death. You'll want to ensure that they are taken care of, even if the tragedy occurs unexpectedly. Once you've determined how much coverage is needed, it's important to find an affordable plan that meets your requirements.
