The goal of personal life insurance for people with dependents is to simply replace the economic earning power of an individual so their family can continue their lifestyle in the same manner as if the person were still alive. For a single individual, the purpose of life insurance is to not leave anyone a financial burden that you created during your lifetime. Either financial amount can be calculated with the formula that follows. We will discuss each part separately and then combine all of the components.
Since we are replacing an income or value, we use that as the base for our formula. Step One of the formula is “3-5x’s your annual income”. We use the range of 3-5x’s because if a spouse does not have equal or any earning power, we lean toward the “5”. If there is an equal earning power between spouses, we lean toward the “3”. If a spouse has earning power but not the primary bread winner, we use “4”. This part of the equation replaces the livable income.
The second part is to cover your housing. If you have a mortgage then this is the number, if you rent, then plan for seven years worth of rent. It may not be the smartest economic idea to pay off the house but to have the option is extremely powerful.
The third part is debts. This includes any debts that would need to be paid off; some examples are car loans, student loans, credit cards, home equity loans, business loans, etc.
The last part is the college fund and since there are large amounts of disparity between colleges, we use 1x’s income/child. This amount at least gives them a head start. If your children are already finished with college then enter 0.
Add all of these together and this is the total amount of insurance needed. You can then subtract how much you already have and the remaining amount is how much new insurance you need.
So here is the formula:
_________
3-5x’s Annual Income
_________
+ Mortgage
_________
+ Debts
_________
+ 1x’s Annual Income/Child
_________
Total
_________
- Less Current Insurance
_________
New Coverage Needed
© R. Allen Greer, Jr., 2007
