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Choosing Terms: How Much & For how Long ?
by Jim Tobin, CFP
One of the most common questions I face as a financial planner is “How much life insurance do I need?” If you'd like to learn a simple yet effective way to go about choosing terms for life insurance, you are in the right place.
As a Certified Financial Planner or CFP, I have had some experience with using (and paying for) complicated software to get and illustrate a complicated answer.
It quickly became clear that people were not all that interested in print outs as thick as a phone book (you do remember the phone book?).
Turns out, most people simply wanted to know what they had to do to protect their goals. If you are in this situation, I have a simple yet effective formula for you to use.
The simple answer to the question “How much life insurance do i need ?" .... The acronym L.I.F.E.
Loans -- Add up all outstanding debt.
Income - Take your annual income and multiply by the number of years until you plan on retiring.
Future - Is there anything on the horizon that you know will have a significant cost?
Education - Do you plan on paying fully or partially the cost of one or more children’s educations?
Adding these numbers together and adding a conservative annual inflation cost will give you a pretty good idea of your "gross need".
At this point you can subtract any savings and 70% of qualified retirement funds (unfortunately we have to be mindful of taxes). Additionally you can subtract any current, personally owned*,life insurance that will be inforce for a useful period (until an expense expires like college).
* I advise against using employer provided life insurance in this initial calculation, as there is no guarantee that a future employer will be able or willing to provide this benefit.
It is best to think of employer provided life insurance benefits as supplemental. This can be especially helpful if budgetary constraints force you into a less than "fully insured" position.
While this formula is very simplistic at it’s base, it allows you to comfortably make provisions for nearly any future expense.
Future expenses do not need to be perfectly planned, but rather, can be structured to accommodate multiple options.
Changing life plans need not disrupt your financial security.
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