How much life insurance is enough?

Making the decision to take out life insurance is easy.  Working out how much cover you need is much harder.

When Do We Need Life Insurance?

Some of the triggers to think about take out life insurance might be:

• Getting married
• Having a baby
• Buying a home
• Taking on debt for any other asset
• Starting your own business

When we have dependents or we take on debts or other responsibilities our thoughts tend to turn to insurance.

Calculating the Amount of Life Insurance Needed

So how do we calculate the amount of Life insurance needed?  By life insurance we mean Term Life insurance where a lump sum is paid on death or diagnosis of terminal illness.

As everyone’s situation is different there is no one size which fits all.  However there are a number of common objectives which typically will be high on the list:

• Provide for funeral costs
• Pay off the home mortgage and any other debts
• Establish an education fund for children
• Provide a rainy day fund for unexpected costs
• Provide an ongoing income for dependents

Most of these objectives are easy to calculate.  However in order to provide an ongoing income for dependents you have to be able to calculate a lump sum which can be invested and provide the desired income in real terms over what could be a long period of time.

This is where Life Insurance Calculators such as the one provided on www.insurancewatch.com.au can be useful.

Using the calculator you can nominate the income that your spouse or family may need on a yearly basis if you are not around – this may involve replacing your current income, replacing your and your spouse’s income if they would have to stop work to look after children or some other amount which you may feel sufficient to meet your family’s living expenses.  If your life insurance is paying off your debts then the income required may be less than otherwise as there will be no more debt expenses.

You also need to nominate the number of years that you would like the ongoing income support to be supplied for.  This may be a fixed number of years i.e. 5, 10 or 20 years or it might be until your youngest child turns 18 or 21.

Finally you need to provide your estimate for the investment return you could earn by investing the lump sum and your estimate for inflation so that the income is kept constant in real terms.

The calculator will work out what amount is required in today’s dollars to meet all of these needs.

But that is not all of the story.  If you have any existing Life Insurance cover, such as through your superannuation fund, this needs to be subtracted, as well as the superannuation balance as this would be payable in the event of your death.  Also if you have any savings and assets which could be liquated by your family these can be subtracted.

The net amount is how much Life Insurance you need to be taken out to meet these common goals.

Other Considerations

Of course you may have other reasons to take out life insurance, such as estate equalization between children, keyperson business insurance, or providing long term support for a child with special needs.

Seeking the help of a life insurance adviser is recommended to ensure that your particular situation is taken into account.