Life Insurance Blog

What is the right amount of Life Insurance?
January 15th, 2009
in Life Insurance

Hello Mr. or Mrs. Client,

“I see that you have $500,000 of 20 year level term life insurance that you purchased four years ago. Is that correct?”

Client, “yes”

“How come you selected that amount?”

Client, “because that is how much my brother has.”

While I am poking fun at this, I have had a thousand different answers when it came to the amount purchased. In fact, I have had that answer numerous times.

All kidding aside, what is the proper way to calculate the amount of life insurance that a person needs? There is no definitive answer but there are several schools of thought on this.

1. A multiple of income- For example 5 or 10 times your income. If you make $100,000 you should have 1 million dollars of life insurance.

2. Needs based- To calculate the amount needed to cover liabilities that will be left behind and to provide ongoing income to the family.

3. Human life value- This concept maintains that a person should carry life insurance that is equal to the present value of the capitalized value of his future net earnings. This ensures that his family will not suffer disastrous financial loss when he dies.

4. Income based- Estimating a conservative return on a death benefit amount. An example: client B makes $50,000 a year and wants to provide his wife Ethel and his son Duke and daughter Lucy at least that same amount in income if he were to pass away unexpectedly. He assumes a conservative return on money safely invested is about 5%. On that basis, he decides he wants to buy 1 million dollars of life insurance. 5% on a principle sum of 1 million would spin off $50,000 a year for his family without touching the principle.

Those are four schools of thought that I seem to hear most, but I know there are others. When speaking with your financial professional, ask them what is the methodology they use.

“If they say, buy as much as your brother”, it may be time to find a new agent.

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