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cash value life insuranceYou know you need life insurance, but you’re not sure how much you need to leave your survivors.

There is some disagreement among experts about how much is enough, including some who say to multiply your income and others suggest just buying enough life insurance to cover your present debts.

Those solutions won’t give you the right answer. Simply put, calculating your life insurance needs requires you to:

  • Conduct an inventory of your finances
  • Think about how your beneficiaries would maintain their lifestyles — that includes paying the mortgage and bills — without you
  • Remember about future expenses, such as college education for your children

How NOT to figure out your life insurance needs

What’s the wrong way to calculate how much life insurance you need? Here are some common but misguided methods.

Don’t multiply your annual salary by seven or eight. While it’s a simple formula, it fails to take into account your individual needs and obligations. Life insurance experts say there’s a good chance you’ll buy too little coverage or more coverage than you need by using a formula such as this.

Don’t calculate your “human life value.” This method uses the income you will earn from your present age until your retirement age, assuming estimated salary increases throughout that period, and then calculates the “present value” of that total.

Key Takeaways

  • The classic formula to calculate the amount of life insurance you need is: Short-term needs + long-term needs – resources = amount of life insurance needed.
  • The calculation may produce a figure that requires a high premium, but people who go through the analysis again typically adjust their initial needs down to more reasonable levels.
  • Shopping for life insurance is the best way to get a rate, but also check the company’s ratings.

The present value is an estimate of the amount of income your family would lose if you were to die today. The problem is it does not take into account your beneficiary’s specific needs. You may also end up with a figure that indicates you should buy a huge amount of life insurance, possibly more than you may need.

“Focusing on any one aspects of an individual’s financial life can create problems,” says Michael Snowdon, financial planner and coach at Snowdon Financial Solutions in Parker, Colo.

Simply replacing future earnings is a little too simplistic an approach to an otherwise complex financial concern. It’s far better to work through a needs analysis to determine what needs actually exist and then work to meet those needs.

Don’t just cover your debts. This method involves buying only enough life insurance to cover debts, such as your mortgage, student loan bills or car loans. It does not consider any future debts or needs, such as childcare or college education costs.

A classic formula for life insurance

Many experts say the best way to calculate the amount of life insurance you need is through a needs analysis, which can be broken down into a simple formula:

Short-term needs + long-term needs – resources = how much life insurance you need.

Snowdon says this method is “probably the most accurate approach in what is an inaccurate and imprecise science.”

Experts advise you to analyze your situation at least once every three years, or whenever you have had a major life change. For example, if you have a new baby, you have to recalculate college education needs and child-care costs. If you own a home, a mortgage is likely your biggest financial burden. Because your mortgage balance decreases with each payment, it’s important to include those revised figures in your calculations.

Five steps to a life insurance needs analysis

A must-know: The equation for the future value of money

Calculating your life insurance needs will require two equations you may have picked up in Finance 101: the future and present value of money.

The future value of money equation tells you how much your money will be worth in a given number of years at a specified rate of interest. This equation is essential if you are calculating how much money you’ll need in the future because of inflation, or what the amount would be if you choose to invest the money at a given interest rate.

The present value of money equation tells you what money payable in the future is worth today at a given rate of interest. This is important if you have an amount of money you need in the future, and you need to know how much money you must invest today to achieve it.

If this sounds complex to you, don’t fret. As long as you have a calculator (preferably a financial calculator, which is used by accountants and finance professionals), these equations are no sweat.

Here’s how the future value of money equation works: Say that average college education costs are $20,000 annually for a private four-year institution, and you want to figure out how much it will cost in four years if college costs keep going up 5 percent per year. You would multiply 20,000 by 1.05 (1 represents the present cost, and .05 is 5 percent inflation) four times (or 1.05 to the fourth power).

So your equation would be this:

20,000 x (1.05)^4


20,000 x (1.05)(1.05) (1.05)(1.05)

The answer is $24,310.13

  1. Add up all of your short-term needs. You can place these into three categories: final expenses, outstanding debts, and emergency expenses.

    Among final expenses are medical, hospital, and funeral expenses, attorney and executor fees, probate court costs, and any outstanding taxes that would need to be paid if you died.

    Among typical outstanding debts are credit card balances, auto loans, college loans, and all other outstanding bills.

    Emergency expenses should include a cash reserve for medical emergencies and repairs to your home or car.

    Calculating final and emergency expenses can be complicated because you don’t know exactly how you’ll need for medical or hospital expenses, but give your best estimates.

    Calculating final and emergency expenses can be complicated, because you don’t have a crystal ball that tells you how much your medical or hospital expenses will be, or if you even will have any.

  2. Add up your long-term obligations, including your mortgage and future college tuition.

    Calculating an education fund is tricky because you have no idea where your children may go to college. Perhaps the best method is to use the present average college cost in the United States and the number of years away your children are from entering college. According to The College Board, tuition can vary from $36,000 for a public, four-year institution to $120,000 or more for a private, four-year institution.

  3. Calculate family maintenance expenses. These include such necessities as child care, food, clothing, utility bills, entertainment, travel, and transportation. Calculate this figure based on a year’s worth of expenses, then multiply that times the number of years you want to provide this income.
  4. Now that you’ve tallied all of your income needs, figure out what resources you have to meet them. To do this, add all available savings, stocks, bonds, mutual funds, the death benefit payable under existing life insurance (such as group life through your employer), and Social Security. You and your spouse can find out how much you’ll get through the Social Security Administration (SSA) by visiting the SSA’s Web site, where you can get an estimate of how much you should have in Social Security benefits.

    It’s important to count only liquid assets (those you can quickly convert to cash) among your resources. You shouldn’t count items like your home or automobile because selling them for cash after you die would mean changing your family’s lifestyle.

  5. Subtract your resources from the amount of capital needed to meet your family’s total financial needs. The figure you get represents the amount of life insurance you should buy.


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Don’t be daunted by life insurance numbers

Snowdon says the final figure that shows how much life insurance you need can be quite unnerving. If you end up with a figure that requires a premium that is too high, he recommends you go through the analysis again and select areas in which you think your family can get by with less money.

“Many people will think they can’t afford coverage based on sticker shock,” Snowdon says. “You have to look at the figure again to determine what is absolutely necessary and make your adjustments.”

Shop for life insurance

Once you figure out how much life insurance you need, it’s critical that you shop around to find the best policy for you. It doesn’t matter what type of life insurance you buy or the size of your policy. Life insurance can vary by price and policy depending on the company. So, once you’ve decided what you need, get quotes from multiple life insurance companies. You should also check the company’s ratings. One place to check is Insure’s Best Life Insurance Companies.

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Penny Gusner


Penny is an expert on insurance procedures, rates, policies and claims. She has extensive knowledge of all major insurance lines -- auto, homeowners, life and health insurance. She has been answering consumers’ questions as an analyst for more than 15 years and has been featured in numerous major media outlets, including the Washington Post and Kiplinger’s.