A commonly asked question regarding life insurance is “how much life insurance is enough?”
Simply put: the amount of coverage needed depends on the amount of debt and income loss the plan has to cover. This is determined by the total assets that can be allocated subtracted from the amount of debt/costs.
The following is an easy way to figure out the amount of coverage you need. Note that this method is an approximation. For greater accuracy please consider contacting Baker & Baker Benefits for a complimentary, no-obligation Life Insurance Needs Analysis.
Simple Life Insurance Calculation
To calculate the amount of required coverage:
1. Figure out the sum total of all financial obligations (home mortgages, funeral costs, car loans, student debt, etc.). Note that the average cost of a funeral in Canada is around $8,000 to $10,000.
2. Decide how many years of income replacement you would like (commonly people want their life insurance plan to cover 3-5 years of lost income). Add this figure to the sum of your financial obligations (see above step). If you do not want to provide income replacement then skip this step.
3. Add together any savings and assets that can be put towards costs, and subtract it from your total calculated above. If you do not want savings/assets to be used for living expenses after you pass away then skip this step. (It is common for assets to be used as an inheritance to surviving children and/or spouse).
4. Round up the resulting amount to the next $100,000.
Here is a sample calculation:
Step #1: Financial Obligations
Outstanding mortgage ($155,000) + credit card debt ($13,000) + student debt ($20,000) + funeral costs ($6,000) + car loan debt ($5,000) = $199,000
Step #2: Income Replacement
3 years salary ($55,000 x5) = $220,000
Step #3: Assets
Investments ($25,000) + bank account savings ($17,000) = $42,000
Step 4: Round Up Required Coverage Amount
Financial obligations ($199,000) + income replacement ($220,000) – assets ($42,000) = $377,000, rounded up to the magic number of $400,000.
Extra Points to Consider
The following points are food for thought when it comes to protecting your loved ones financially:
• Try to anticipate all the costs that you would like covered. If you don’t get enough now you may not be able to get more coverage later (and if you do qualify for additional coverage in the future it will cost you more money as you age.)
• Review your group coverage with your employee benefits, your insurance advisor should help you with this. Depending on what your situation this may factor into your calculation but remember group coverage is only valid if you are an employee. If you lose your job or become self-employed, your employee benefits no longer apply.
• Consider the type of plan you would like. Term life insurance is the cheapest type of plan and offers protection for the given term as long as premiums are paid up. The longer the desired term (how many years of protection), the higher the premiums. Permanent life insurance (e.g. universal or whole life) offers the same protection as term life, along with the added benefits of building up cash value as well as other wealth management aspects. Note that many people opt for a simple term life plan, and then use other investment vehicles to manage their wealth (e.g. RRSPs, TFSAs, RESPs, etc.).
Contact Baker & Baker for more information today!