Once you’ve decided to obtain term life-insurance coverage to protect those dependent on you, you need to determine the amount of coverage needed. There are plenty of calculators online, but my quick-and-dirty approach is as follows:
- Determine the expected annual spending of those you’ll be leaving behind. A detailed analysis would be nice, but you can simply go with either (a) 36 times the monthly rent they’ll be paying or (b) 20% of the sales value of the home where they’ll be living. I discussed these estimates in one of the early lessons on financial independence planning.
- Subtract expected benefits from Social Security and other pensions to determine the annual spending gap that needs to be covered.
- Subtract the salary of your partner to the extent it is reasonable to expect him or her to work. Be overly conservative if there are preschool children and no grandparents to help with care. Be aggressive if the kids are already teenagers.
- The remaining income needs to be provided by life insurance. Multiply the annual amount by the number of years needed, but no more than 20, since that length of time allows the funds to be invested for long-term growth.
The idea, in my opinion, is to make sure they can manage without you and not to give them a lavish lifestyle. Remember that you almost certainly are NOT going to die prematurely, so while you want to protect them against disaster, you don’t want to throw away premiums that, if saved and invested, will make your family more financially comfortable even if you have the misfortune to continue living.
For the same reason, I think you should make reasonable assumptions about the family moving to less-expensive residences and areas in the event of your death. As I mentioned in the last lesson, don’t ignore the assistance that would be forthcoming from parents, grandparents, and dear friends. Through most of history, insurance came from mutual commitments within communities, and if you have such a community of support, save and invest instead of handing money to an insurance company. I’m a great believer in the value of profit-making entities, but mutual aid after a death in the family has monetary value that should be recognized where it exists.
Okay, I’m sorry I had to kill you. Next week, I’m going to let you live, but give you a serious injury or illness instead.