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  • How much life insurance do I need?
  • June 28, 2013
  • Tony Steuer

    By Tony Steuer, CLU, LA

    This question has as many answers as there are people to ask. Every adviser, financial columnist, and relative has their own formula that they consider to be the best.

    This article is aimed at presenting various methods used, as well as the pros and cons of each one, which can range from fairly simple to extremely complex. This is a very complex process, since it deals with how to value one’s life.

    The method that makes the most sense to you is probably the one that will work the best. But remember, no method is perfect.

    Life brings many new changes, which could alter your insurance needs. The more assumptions you make, the more complex you’ll make your planning, and the more chances there are that something will not work as planned.

    This does not mean that you should only use the simplest method – it is to give you a concept of why it is important to actively participant in all of your planning, fully understand it, and constantly monitor it. After all, it is your money.

    Remarkably, the simplest formulas can often be the best.

    There are several ways to determine how much life insurance to buy.

    All of the issues discussed in this question, will have an impact on the amount of life insurance needed. Often the desired goals may not be financially feasible. These issues are not only financially based; they can also be extremely emotional.

    Another thought to keep in mind is that as your other assets grow, such as retirement plans and investments, your need for life insurance will decrease.

    Here are some of the more commonly used approaches:

    Multiple of Income

    Multiple of Income, also known as the “human capitalization value”, is one of the oldest, best-known methods, but also the easiest. This method uses the approach of a multiple of your annual income – typically ranging from five to eight times your annual income.

    While simple, this  method misses a range of important factors. For example, household demographics, past savings, Social Security offsets, housing expenses, taxes, etc.

    It also ignores expected life changes and individual preferences about sustaining the living standards of survivors.

    It is simply a “best guess.”

    Cover Your Debts

    This is a method of buying only enough life insurance to cover debts, such as mortgage, student loan bills, or outstanding car notes. This has similar issues as the previous method, as it misses a whole range of factors.

    This method is also too simplistic to provide any real value.

    Human Life Value Concept

    The human life value concept deals with human capital, which is a person’s income potential. We all have a human life value. In wrongful death litigation, human life value is measured daily in court; however, the litigation value tends to be significantly different.

    Insuring human life value is the primary purpose of life insurance, and this method does beyond numbers and figure. It considers the entire impact when a human life is lost.

    Here are some questions to give you a start.

    – If you were killed in a car accident last week, and someone else was responsible for your death, how much would your family sue the responsible party?

    – If you were killed in a car accident last week, and you were responsible, how much money would you want your family to receive?

    – If you died last week from cancer, how much money would you like to leave your family?

    – How much are your tomorrows worth?

    – What is your Potential Earning Power (PEP)?

    Click here for an easy-to-use life insurance needs calculator, which was developed by the Life Foundation.

About Tony Steuer

Noted insurance author Tony Steuer has spent over 25 years in the life insurance industry. Steuer’s leadership roles include serving on the California Department of Insurance Curriculum board and the National Financial Educator's Council Curriculum Advisory Panel as well as having served as President of the San Francisco Chapter of the American Society of CLU & ChFC, President of the leading Life Insurance Producers of Northern California, and as a board member of the San Francisco Life Underwriters Association. Mr. Steuer is the author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, The Questions and Answers on Life Insurance Workbook and The Questions and Answers on Disability Insurance Workbook - the first two were awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy. Steuer holds a Chartered Life Underwriter (CLU) designation and also holds the Life and Disability Insurance Analyst License, a designation that is held by less than thirty people in California.

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Questions & Answers on Life Insurance by Tony Steuer, CLU, LA, CPFFE is licensed under a Creative Commons Attribution 3.0 Unported License.

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