Find out if your loved ones are adequately covered by your policy. Learn to calculate your life insurance needs.
Some of you may wonder if there is a correct way to properly analyze your life insurance needs. After all, where do insurance agents, advisors, and financial planners come up with this magical number? The simple answer to this question is yes, there is a recommended method, but it is far from magical. The equations used to calculate this value prevents you from being under insured and should accommodate your current goals and future needs.
There are generally three methods to estimate your life insurance needs. The first method and probably the simplest way to estimate your life insurance needs is called the “multiple of income approach.” This method utilizes a multiplier to calculate the financial support needed based on the income of the family's breadwinner. It will simply estimate the needed income replacement the beneficiaries need for a set period. The problem with this method is it does not take into account numerous factors like inflation or taxation, nor does it take into consideration the actual needs and future plans.
“The Human Life Value” approach is the
second method used to calculate your needs, but just like the first method, there are many factors that are not accounted for. To estimate the insurance required, you simply take the insured's present and future earnings until a set time in the future (this is typically the insured's retirement age) and add them. Then you subtract the annual taxes and COL expenses from the estimated earnings to arrive at a gross value. At this point, you estimate a rate of return on the net value of the earnings, then subtract the expenses and estimated growth from that total to arrive at a net value. Based on that value, you would then add the cost of inflation along with other expenses like healthcare, funeral expenses, and other benefits that will need to be replaced when the insured dies to estimate total life insurance needed.
The “capital needs analysis” is the third method used to estimate your life insurance needs. This method provides a more in depth approach as it factors in the couple's future income and future needs including future plans and expenses such as your dependents' education, your own long-term care, even your retirement needs.
To calculate your life insurance needs based on this method, you would first, take all your “current financial obligations, debts, and liabilities” and add them up. Then, considering your future plans, estimate your expenses and funeral costs and subtract that value from your current assets and life insurance in force. Taking into account taxation and interest charges for future expenses.
As you can see, the capital needs analysis requires a more thorough look at your financial health. This method allows for a better analysis, providing you a better estimation. To help you determine your life insurance needs and get a better understanding of the whole process as well as all your options, you can connect with one of our licensed advisors.
