Life Insurance Planning
Life Insurance and Why You Need It
Planning for the financial consequences of a premature death is
an essential part of every financial plan. Generally, the consequences
are simply too large to ignore and cannot be totally covered with
your own resources.
Life insurance protects your family against the risk of the premature
death of you (or your spouse). Life insurance planning should consider
your family's short term needs (for example, your funeral or medical
expenses) and long-term needs (for example, replacing your income).
Methods of Life Insurance Need Calculation
1) Financial Needs Method
This method focuses on the expected financial needs of the survivors,
including:
- Family income needs.
- Emergency funds.
- Estate settlement and administration costs.
- Family educational costs.
- Paying off debts.
- Survivor retirement needs.
This method requires that you estimate the amount of the income needs
that are relevant to you. If you are married, you would consider the
financial impact of the death of either spouse. Plus, you would evaluate
how long each need will last and whether each need will increase or
decrease over time. Knowing the duration of each need can help you
select an appropriate insurance product. You would also factor in
the impact of inflation on long-term needs.
Once you calculate the financial impact of a premature death, you
can compare the amount to the resources you currently have available.
If there is a difference, you can decide which needs to address first
and begin to explore alternative ways to fund any shortfall.
2) Rule of Thumb Method
This method calculates your need for life insurance as a multiple
of your annual salary or earnings. Clearly, this method is very simple;
however, it may not allow you to address all of your individual financial
goals. In addition, different advisors suggest different multiples.
This makes the calculation of a precise amount difficult.
3) Income Replacement Method
This method focuses on the replacement of some percentage of salary
or earnings for a specified period of time. The value of the income
replacement can be calculated and compared to the assets you currently
have. Any difference between needs and resources can be funded with
life insurance.
While this method is not difficult to calculate, it may not adequately
take care all of your financial needs if your present income does
not fully fund these goals. Do you know the how much additional
income you might need?
Please review the table below as a guidepost to help you determine
your life insurance needs. This table shows the amount of capital
or insurance proceeds required to take the place of a given amount
of income at a given age:
Income Replacement Method Table - Amount of Income to be Replaced
Until Age 65
| Insured's Current Age | ||||
| Current Ann. Income | $ 25,000 | $ 50,000 | $ 75,000 | $100,000 |
| 30 | $506,000 | $1,012,000 | $1,518,000 | $2,024,000 |
| 35 | $445,000 | $890,000 | $1,335,000 | $1,780,000 |
| 40 | $381,000 | $762,000 | $1,143,000 | $1,525,000 |
| 45 | $314,000 | $628,000 | $942,000 | $1,256,000 |
| 50 | $243,000 | $486,000 | $728,000 | $971,000 |
| 55 | $167,000 | $334,000 | $501,000 | $669,000 |
Assumptions:
- Income increased each year at a 4% annual inflation rate and is taxed at a 30% effective tax rate.
- Capital or insurance proceeds are invested at an after-tax rate of 5%.