How to determine the right amount of Life Insurance

Experts in the life insurance industry have a number of different methods that are used to recommend an optimal amount of life insurance. From simple techniques such as multiplying your annual salary by ten to complicated simulation algorithms, there are many different ways to calculate life insurance requirements. Many of the life insurance calculators that are provided online utilize a method known as needs analysis, which in general, involves estimating the financial needs of the people who depend upon you and forecasting these needs into the future.

A good way to start the needs analysis planning process is to look at the expenses incurred in a typical month and then multiply the figures by twelve to come up with an annual estimate. Be sure to think about all of the categories of expenses, including but not limited to housing, food, utilities, transportation, medical care, and clothing. You will also need to determine if new expenses would come into play if you were no longer around. For instance, would your stay-at-home spouse go back to work? Would child care expenses increase?

Once you have a realistic estimate of expenses, it's time to examine sources of income. Be sure to include salaries, rental income, investment income, and Social Security payments, if applicable. Once you deduct the estimated expenses from the estimated income, the remainder is the amount that needs to be covered with the proceeds from a life insurance policy.

There's another component that you need to consider when estimating the amount of life insurance that you should purchase. Don't forget to consider lump-sum expenses that a life insurance death benefit should cover; these expenses are items such as funeral costs, student loans, and credit card balances. In some cases, people who purchase life insurance choose to reduce the debt load of their dependents by paying off such loans as the home mortgage or car loans. While this is not mandatory, reducing the expenses for the surviving spouse does provide them with increased financial peace of mind.

The last piece of the needs analysis process involves subtracting any current assets that would be liquidated if you were to pass away. For example, if your spouse were to downsize to a smaller home, then you should consider the difference between the value of your existing home and the value of the future home, and this difference will reduce the amount of life insurance that you need to buy.