How to Determine the Necessary Amount of Life Insurance

HOW TO DETERMINE THE NECESSARY AMOUNT OF LIFE INSURANCE

Step	Description	Example
1.	Determine the “reduced” monthly budget of the family excluding the mortgage payment and any amount that the family invests or saves to pay for children’s college. Assume it is $8,000. Multiply this by 12 to obtain the reduced annual family budget.	$96,000
2.	Let us assume that when the insured dies the family expenses are reduced by 20%. The reduced after-death annual family budget is $96,000 X (1 – 0.20) or $96,000 X 0.80	$76,800
3.	Let us assume that the spouse annual salary is $26,800. The adjusted reduced after-death annual family budget shortfall is $76,800 - $26,800	$50,000
4.	Let us assume that the surviving spouse is going to invest the death benefit proceeds in an account that earns an annual rate of return of 5% and the family is going to use only the interest generated by this account. The death benefit necessary to cover the adjusted reduced after-death annual family budget shortfall is $50,000 / 0.05	$1,000,000
5.	If the insured already has other life insurance with a death benefit of, let’s say $300,000, the additional amount of necessary insurance (not counting mortgage, college education and final expenses) is $1,000,000 - $300,000	$700,000
6.	Let us assume that the amount necessary to pay off the mortgage is $300,000, the amount necessary to pay the children’s college is $200,000 and the estimated final expenses are $50,000. The total amount of life insurance needed is $700,000 + $300,000 + $200,000 + $50,000	$1,250,000
7.	If the insured cannot afford to pay for the $1,250,000 in universal life permanent insurance he or she should buy term insurance for those events that have a limited time duration like payment of the mortgage and college funding, or $300,000 + $200,000, or $500,000 in term insurance and the rest, or $750,000 in universal life permanent insurance.	At least $750,000 in universal life, and $500,000 in term insurance