There is little that seems to make people more uncomfortable than talking about life insurance. This could be partly because it has to do with dying, or because they were oversold insurance at some point in the past by a product pusher. Either way your family will benefit tremendously if you do some planning now.
There will be a lot to deal with if they lose you. You don’t want them scrambling trying to find funds just to pay the bills on top of everything else they will have to take on.
So how much life insurance should you carry? I have actually heard a life insurance agent say, “as much insurance as the person can afford to pay in premium.” Obviously this isn’t the right answer.
There are a couple techniques we can use but today we are going to talk about replacing just your lost income. That is, how much you contribute, monetarily at least, to the family.
The first step is to calculate how much of your income actually makes it to your family. In our example we have someone making $80,000 in income that loses $20,000 to taxes and spends $30,000 on themselves, that leaves $30,000 that gets contributed to the family.
If this person is 35 years old and plans on working to age 65, we need to manage the risk that they could die this year and the family could lose out on that income. We are simply going to calculate how much we need in a lump sum that can be invested conservatively that will create a payout of $30,000 per year over 30 years.
The lump sum – also called present value in time value of money calculations – necessary to create this income stream is $588,013 if we assume the funds can earn 3%. The higher the assumed investment return/interest rate, the lower the lump sum and vice versa.
Now some caveats. This calculation only replaces income; this is usually the minimum needed when someone passes. There may be some other expense/goals you want covered if something were to happen to you. For example, the creation of an emergency fund, a funeral fund, covering college expenses and paying off all debts to name a few.
This calculation also does not account for increases in salary over the 30 years. This is not that big of a deal though because you are already living off your current salary, not the one you may earn 10 or 20 years from now.
If you haven’t put together a risk management plan you should contact your CERTIFIED FINANCIAL PLANNER™ to get started immediately.