Wednesday, May 11, 2011

HOW MUCH LIFE INSURANCE DO YOU NEED?

After you understand the purposes of life insurance (see Chapter 1) and decide that you need a life insurance policy, the next step is determining how much protection you should buy. This chapter shows you how to determine how much life insurance you need by explaining how to judge the economic value of your life and your survivors’ needs. This chapter also includes a worksheet so that you can make your Calculations.

The Economics of Your Life

The basic step in determining how much life insurance you need is to figure out just how much your life is worth. When looking at the economic value of your life, focus on three things:
  • Your income
  • Your cost of living
  • Any uninsured medical costs

Your income

The value of your income is relatively easy to calculate: It’s the amount of money you earn, plus the amount of money you’d expect to earn if you hadn’t died prematurely. But this figure can be difficult to determine accurately. For one thing, many people have little idea of what they may be earning five years from now, especially younger people who may not have settled into a career yet. Secondly, more and more people change careers (not just jobs, but careers) numerous times in
their lives. The average number of careers (again, not jobs) for people is now over five! How can anyone possibly say what his or her income will be in 15 years?

Your best bet when figuring the value of your income is to estimate how much your annual salary is likely to increase each year. When completing the worksheet in this chapter,use an increase of about 5 percent per year. You can see an example of how your salary may grow in Figure 2-1. If you know your salary increases will be more than 5 percent per year, use the higher figure. If you know your increases will be less than 5 percent, use the lower number. You can round off later in the final formula when you determine how much life insurance you need.

Don’t forget that in five or ten years, you may quite possibly be working for a different organization or in a different job. If you underestimate your increases, you’re also underestimating the amount of income protection that your survivors
need

Your cost of living

The economic value of your life is not only how much you will be earning but also the cost of living — that is, how much you actually need to live on. More importantly, the cost of living you and your family have set up is really the amount
of life insurance income protection you need to purchase — especially because most people tend to spend a bit more than they bring in.

In addition, part of your living costs are more than likely going into some sort of savings — to pay college expenses when your children are old enough, to go toward your retirement, to cover a big vacation, and so on. You still want your survivors to be able to save for some of these items (college expenses, for example). But clearly, saving for your retirement isn’t something you have to be concerned about if you die.

The budget worksheet that follows can help you determine your cost of living. Note that most of your expenses increase over the years due to inflation, if nothing else. On the other hand, some expenses may decrease or be eliminated because they are no longer necessary. One of these, of course, is the life insurance premium. But some other examples of unnecessary costs are clothing, food, and other expenses for children who will eventually be out on their own and paying their own expenses.

Note also that this budget doesn’t include unusual expenses, either planned (such as college expenses or weddings, unless your budget includes saving for them) or unexpected (such as medical emergencies or funerals).

And note, finally, that the budget worksheet doesn’t include paying off any large debts which you’re currently paying over time. If you want your life insurance to pay off some or all of these debts, make sure that you increase the death benefit
to cover these amounts so that your survivors no longer have to include the debt payments in their budgets.

Your uninsured medical costs

Uninsured medical costs are one of the biggest potential drains on a family budget. Including uninsured medical costs in your family budget is crucial because health insurance terms, benefits, and regulations change so quickly.

Moreover, because life insurance protection is related to your health, by definition you want to be certain that your survivors can pay for your medical costs should you die. So after completing the budget worksheet, add a flat amount at the bottom to pay for these unexpected and uninsured medical costs.

How much to add? Good question. The figure you decide on will vary depending on what kind of health insurance you have now. If you belong to an HMO, most of your medical
expenses are covered. On the other hand, if you have a private plan in which you pay 20 percent of the costs, your portion is likely to be far greater. Only you can really estimate this amount. However, most experts say that you should always maintain approximately three months worth of living expenses available, so try adding that amount to the bottom of the worksheet as your emergency fund to cover these uninsured medical costs.

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