The basic calculation is as follows: Amount of Life Insurance = Immediate death expenses + Present value of family needs - Available assets.
Let’s dive into each part of this equation a bit more closely:
1. Immediate Death Expenses
The first thing to consider when using the family needs approach is: How much do you anticipate your family will have to pay for your funeral and other death-related expenses?
Upon your death, your family may be faced with your final expenses, which could include any medical treatment or end-of-life care you may have received, as well as your funeral and burial costs. The average cost of a funeral differs from state to state, and prices can vary wildly for items such as caskets, headstones, and urns. You may want to choose these items on your own and communicate your wishes to your family, making note of the funds to purchase them. Another thing to consider is the cost your family may face to settle your estate. You should factor in potential attorney fees, probate costs, inheritance and estate taxes (if applicable), as well as any debt you currently owe that would reduce the value of your estate.
2. Expected Family Needs
Next, ask yourself: What amount of money would be needed for your family to maintain their current lifestyle?
Here, you should factor in all of the current expenses your family has that they would continue to have after you pass away. This should include housing and utility expenses, food and clothing costs, tuition payments and childcare expenses, transportation costs, as well as entertainment. You should also factor in any funds that your family will need to put aside regularly into savings accounts, emergency funds, college funds, or retirement accounts.
It’s worth noting that your family’s needs will likely change over time. You may start out needing more life insurance while your children are young and in daycare, but as they reach adulthood a lot of those child-related expenses may drop off your family needs list. Likewise, you may initially want your life insurance to allow your family to cover the cost of your mortgage, but that becomes less of a concern once you’ve paid off your mortgage. For this reason, it’s important to re-evaluate your family needs from time to time, and adjust your life insurance accordingly.
3. Available Assets
Once you calculate the expected financial needs of your family, ask yourself: What sources of income will be available to your family after you die?
Funds your family may have access to include Social Security survivor benefits, pension death benefits, your spouse’s wages and the value of any assets you own such as real estate and bank accounts (including CDs, savings accounts, and checking accounts). Other potential assets you might include in your calculation include:
• IRAs, pensions, 401(k)s
• Any life insurance you already have through your employer
• Investment accounts
• Savings bonds
• Artwork, jewelry and other goods of value
After determining the answers to the above questions, you should add up your foreseen death expenses, as well as the ongoing costs you expect your family to face. Be sure to account for the necessary number of months and years your family will realistically need to cover those expenses. Then, deduct the assets you expect them to have access to. The remaining number should give you an idea of how much life insurance you need to purchase.
It sounds pretty straightforward, but the family needs approach can get a bit complicated when you’re trying to account for your family’s needs across many future years. If you’re having trouble with your calculation, there are several worksheets available online to help you streamline the process.
By focusing on the immediate and ongoing financial needs of your surviving family members, and accounting for any income and assets they will be able to tap into following your death, you can help determine the amount of life insurance that makes sense for you.
BankFive is committed to helping our customers thrive financially, and we welcome any questions you may have about taking out a life insurance policy. If you’re interested in starting a conversation, contact us today.