Are you wondering how much life insurance you need? This is one of the more common questions people have when setting up a new life insurance policy, and it is not a matter to take lightly.
You understandably are purchasing life insurance to financially provide for loved ones after your passing, so the last thing that you want is to be underinsured. Doing so could leave your dependents in a stressful financial situation.
On the other hand, buying more insurance than you need will unnecessarily inflate your premium and prevent you from achieving financial goals in your living years.
How Life Insurance Benefits Are Commonly Used
Before arriving at a firm figure for your new life insurance policy’s death benefits, consider how your death benefits could most strategically be used. Because your loved ones’ financial situation may vary dramatically from someone else’s, there is no single method of selecting death benefits that is ideal for everyone.
Understanding how life insurance benefits are commonly used is a great starting point for creating a financial plan for your beneficiaries after your passing. These are some of the more common ways that life insurance death benefits are used:
Pay Off Debts
Each debt, such as a loan or a credit card, has a minimum monthly payment. These payments can inflate your family’s monthly budget. By using life insurance proceeds to pay off the debts, you may dramatically reduce the income they need to live comfortably after you pass away.
After your passing, your loved ones may experience financial hardship because your income is no longer available to pay for essentials and to support the lifestyle that they are accustomed to. Life insurance benefits can replace your income for a period of time or indefinitely in some instances.
Prepare a Spouse for Retirement
A portion of your current income may be allocated to retirement savings and investments. Without your income, your spouse may need to work until he or she reaches an advanced age. Your life insurance death benefits may be used to supplement your spouse’s retirement fund after your passing.
Pay for Major Expenses
Even if your family experiences no major financial impact on a monthly basis from your passing, major expenses may create stress. For example, your family may not be able to pay for a child’s college education, first car or wedding.
Some people incorporate additional death benefits for special purposes. For example, you may want to make a substantial charitable donation to support a meaningful cause, or you may want to leave your loved ones an inheritance.
Create a Financial Plan
With your current household budget in front of you, create a projected budget that shows your family’s income and expenses after your passing. This step is essential when determining how much life insurance you need.
For example, your income will no longer be available. Perhaps your vehicle will be sold, so the auto loan payment will be eliminated. If your spouse stays home with the children, he or she may return to work and generate a fresh source of income.
However, childcare expense may be added. Many line items in your budget may need to be tweaked in this way. After you have revised your budget, you can determine what your family’s financial shortfall will be.
There are two primary ways to financially support your loved ones through death benefits, and you may decide that one or a combination of both methods works well for your situation.
First, consider how much money would need to be applied to debt payoff to eliminate monthly payments and reduce your family’s income needs. Second, consider how much cash infusion your family needs each month to maintain their current lifestyle.
Rather than pull money directly out of the death benefits for this purpose, think about how the money could be safely invested. For example, the benefits could be invested in CDs or in low-risk, dividend-producing stocks. Your family could live off of the return without ever eroding the principal.
By reviewing each of these points, you may have a better idea about the death benefits that your family needs. The next step is to determine if you can afford the premium on the full amount of death benefits needed. Gather several quotes from leading providers, and think about comparing rates based on different term lengths.
Once your life insurance policy is set up, review your plan with your beneficiaries. You may even prepare written instructions regarding your planned use of the benefits so that oversight or forgetfulness does not result in unnecessary financial hardship.