If your family relies on your income, it’s critical to have enough life insurance to provide for them in the event of your passing. But too often, life insurance is an overlooked aspect of personal finances.
According to a study conducted by LIMRA, which closely follows life insurance trends, less than half of U.S. households have individual life insurance coverage, and 40% of Americans say they need more coverage.1
Recognizing the role life insurance can play in your family finances is an important first step. A critical second step is determining how much life insurance you may need.
Rule of thumb
One widely followed rule of thumb for estimating a person’s insurance needs is based on income. Waddell & Reed typically recommends a life insurance policy that is 10 times a person’s annual income. If you’re looking for a more accurate estimate, consider completing a “DNA test.” A DNA test is a Detailed Needs Analysis that takes into account a wide range of financial commitments to better estimate insurance needs.
The first step is to add up needs and obligations.
Short-term needs include final expenses, such as a funeral, final medical bills, and outstanding debts, such as credit or personal loans. How much you should make available for short-term needs will depend on your individual situation.
To determine long-term needs you’ll need to consider how much it will cost to maintain your family’s standard of living, specifically necessities like housing, food and clothing. Also, you should factor in expenses such as travel and entertainment. Answering the question, “What would it cost per year to maintain this lifestyle?” is good place to start.
Beyond your family’s known long-term needs, you’ll have to consider anticipated, yet unknown future expenses. Will you be able to afford your children’s college tuition? Will your aging parents need your support? Factoring in potential new obligations allows for a more accurate picture of ongoing financial needs.
Once you’ve finished adding up your needs, subtract all liquid assets.
Any assets that can be redeemed quickly and for a predictable price are considered liquid. Examples of liquid assets include cash, money market accounts and government bonds. Illiquid assets, on the other hand, are assets than cannot be sold quickly for a standardized price. For instance, houses and cars are not considered liquid assets since they may require time to sell.
Needs and obligations — minus liquid assets — can help you get a better idea about the amount of life insurance coverage you may need. While this exercise is a good start to understanding your insurance needs, a more detailed review may be necessary to better assess your situation.
1 LIMRA, 2016
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