As life changes, so do your life insurance needs. When you’re young, you may not need very much life insurance. However, as you take on more responsibility and your family grows, your life insurance needs increase, too. Those needs may decrease again after your children are grown and living on their own. That's why you may need to rethink your coverage periodically. Here are a few guidelines for doing just that.

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How to Estimate Your Life Insurance Needs

There are a couple of methods that you can use to estimate your life insurance needs. I’ll walk you through them step by step.

1. Income Rule

The most basic rule of thumb is the income rule, which states that your insurance need is equal to six or eight times your gross annual income. For example, a person earning a gross annual income of $60,000 should have between $360,000 (6 x $60,000) and $480,000 (8 x $60,000) in life insurance coverage.

2. Income Plus Expenses

This rule considers your insurance need to be equal to five times your gross annual income plus the total of any mortgage, personal debt, final expenses, and special funding needs (e.g., college). For example, assume that you earn a gross annual income of $60,000 and have expenses that total $160,000. Your insurance need would be equal to $460,000 ($60,000 x 5 + $160,000).

3. Family Needs Approach

This approach requires you to purchase enough life insurance to allow your family to meet its various expenses in the event of your death. Under the family needs approach, you divide your family's needs into three main categories:

  • Immediate needs at death (cash needed for funeral and other expenses)
  • Ongoing needs (income needed to maintain your family's lifestyle)
  • Special funding needs (college funding, bequests to charity and children, etc.)

Once you determine the total amount of your family's needs, you purchase enough life insurance to cover this total amount.

4. Income Replacement Calculation

This approach is designed to cover a breadwinner's income in the event they pass away unexpectedly. For example, if you're the breadwinner, the amount of life insurance you should buy is based on the income you expect to earn during your lifetime. This should take into account things like inflation and raises, as well as the interest that the lump-sum life insurance proceeds will generate. If you need my help to figure this part out, just let me know.

5. Estate Preservation & Liquidity Needs Approach

If you have a large estate you'll leave behind, this method may work best for you. We'll calculate the amount of life insurance you need to settle your estate, including estate taxes, and funeral, legal, and accounting expenses. By doing this, we can preserve the value of your estate as much as possible, preventing your heirs from having to sell assets to pay estate taxes. To use this method, we'll take two things into consideration: (1) maintaining the current value of your estate for your family, and (2) providing the cash needed to cover your funeral expenses and taxes.

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