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
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.
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.
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.
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.
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.
