When we hear of life insurance, the first thing we think about is death. This makes sense because life insurance can cover funeral expenses and it can provide for our loved ones when we die. But once the policy matures and you are still alive, you can exchange your cash value policy for an annuity and enjoy the benefits. The question is, will your insurance coverage be enough to replace your income? This is why it’s important to calculate how much you will really need before buying life insurance.
Here’s how to determine the amount you will need or the coverage that is right for you:
Calculate Your Monthly Living Costs
How much do you normally spend in a month? Include the housing, the utilities, food, transportation, and even the emergency fund. There are a lot of things that come into play when it comes to budgeting so there is no one-size-fits-all answer to this. Housing alone can take a hefty sum of your take-home pay especially if you live in a major city. If you just got your first mortgage, you should add that to the computations of your life insurance costs. It’s important to add especially if your mortgage term is more than 20 years. The food budget and groceries are things that normally change from month to month. It matters that you have a fair amount of wiggle room for things that have a variable cost.
Let’s add inflation into the picture and your typical budget will eventually double or even triple. Over a period of time, the prices of goods will go up so it matters that you are prepared for the sudden increase of consumer items. A personal budget tracking software such as Quicken can help you manage your overall finances. It can help you track so many aspects of your financial life, right from your savings down to your investments.
Without budgeting, it is so easy to commit the mistake of spending more than you should and forgetting about saving. So start tracking your expenses so you will be accountable for every dollar you spend. If you don’t have a budget tracker and you are too busy to do it manually, you may use your bank statements to get a picture of your typical expenses. Your account statements will present your monthly cash flow in a realistic manner.
Multiply Your Annual Salary By 10
Let’s say your monthly take-home pay is $4,000 after taxes. In a year, you will have a total of $48,000. Subtract all the expenses that will cease when you are gone, like gym membership and dental insurance. Let’s say you got a remaining $2,800. Multiply the answer to 10. That amount should be enough to give your family a comfortable life even when you are not around. If you are the breadwinner, then stick to this computation.
But let’s say it is you and your spouse both providing for the family. Add your spouse’s income to the computation, again minus the taxes and the expenses that will cease when your spouse is gone. The reason why we are multiplying the annual salary by 10 is to come up with an amount that will cover even the anticipated expenses. We should not forget about inflation and the unexpected expenses when calculating the amount of coverage, we really need for our life insurances. Kind of think of this as a rehab situation for your spouse.
Where do you stand on the lifestyle spectrum? If you live a comfortable lifestyle, eat well, and like traveling, live in one of the major cities in the United States, you probably need to have more coverage.
In just a few years, all the prices of food, education, housing, and health care could double due to inflation and the high demand because of the increasing population.
Compute the Total Amount of Your Debt and Your Savings
When you have existing debts, you obviously don’t want your family to pay them off for you when you die. While you are still here, pay off your debts even before building your emergency funds. In fact, it will be easier for you to start saving once all those debts have been paid off. But there are kinds of debts that usually take longer to pay off.
Mortgage, for instance, takes more than years to finish. If you are still paying for your housing, include this when computing for your life insurance coverage. Who will pay for the mortgage and the estate taxes when you are gone? Unless your children are financially secured enough by that time, then you probably should not worry about this part.
Speaking of saving money, it matters to add your long-term saving goals to the computation. Long-term goals refer to goals that will take more than five years to complete.
While some of us think of future automobile purchase and the education for the kids, we should not forget the most important of all: our savings for our own retirement. The amount you need should be more than enough to cover your expenses during old age.
Life insurance can secure you and your beneficiaries from financial loss. Beyond that, life insurance can be your source of income in case any uncertain event happens. If you haven’t bought your insurance yet, it’s important to calculate how much you will really need. That way, you and your loved ones will be fully covered by the time you need it.