Life Insurance—How Much Is Enough?
You are probably aware of the importance of having enough life insurance coverage to handle the financial contingencies that may affect your family in the event of your death. Determining the necessary amount of life insurance can be complicated. One general rule of thumb is that you should have enough coverage to equal five to ten times your annual salary. However, you should determine the “right” amount of life insurance coverage for you and your family with a careful “needs analysis” rather than using an arbitrary formula.
The needs analysis approach incorporates an evaluation of your family’s most important financial obligations and goals. This leads to planning insurance coverage to help address mortgage debt, college expenses, and future family income, as well as to provide liquidity for meeting future estate tax liabilities.
The first point worthy of consideration is whether your life insurance proceeds will be sufficient to help pay the remaining mortgage on your home. If you are carrying a large mortgage, you may need a sizable amount. If you own a second home, that mortgage should also be factored into the formula.
Many people want life insurance proceeds large enough to help cover their children’s college, and possibly graduate school, expenses. The amount needed can be roughly calculated by matching the ages of your children against projected college costs adjusted for inflation. This calculation should be revised periodically as your children get closer to college age, and it may be a good idea to be as conservative as possible when estimating long-term financial goals.
Continuing Income for Your Family
The amount of income you will need to help provide for your surviving spouse and dependents will vary greatly according to your age, health, retirement plan benefits, Social Security benefits, other assets, and your spouse’s earning power. Many surviving spouses may already be employed or will find employment, but your spouse’s income alone may not be sufficient enough to cover the monthly expenses of your family’s current lifestyle. Providing a supplemental income fund can help your family maintain its standard of living.
Life insurance has long been recognized as an effective method for establishing liquidity at death to pay estate taxes and maximize asset transfers to future generations. However, this use of life insurance requires qualified legal expertise to help ensure the proper results.
If your current assets and retirement plan death benefits are sufficient to cover your financial needs and obligations, you may not need additional life insurance for these purposes. However, if they are inadequate, the difference between your total assets and your total needs may be funded with life insurance.
There are many factors to consider when completing a needs analysis. In addition to the areas already mentioned, some other questions you might want to address include the following:
1. How much will Social Security provide and for how long?
2. How do you “inflation-proof” your family income, so the real purchasing power of those dollars does not decrease?
3. What is the earning potential of your surviving spouse?
4. How often should you review your needs analysis?
5. How can you use life insurance to help provide supplemental retirement income?1
6. How do you structure your estate to reduce the impact of estate taxes?
7. Which assets are liquid and which would not be reduced by a forced sale?
8. Which assets would you want your family to retain because of sentiment or future growth possibilities?
9. If your spouse remarried, how would that impact any college savings plan currently in place for your children?
As you develop an insurance strategy, remember to analyze your existing policies. Calculate the additional coverage you may need based on your family’s financial obligations and any other resources, such as retirement benefits and savings. Remember, having the proper life insurance coverage can play a major role in any family’s financial protection.
1 Access to cash values through borrowing or partial surrenders will reduce the policy’s cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.
The information contained in this article is for general use and while we believe all in formation to be reliable and accurate, it is important to remember individual situations may be entirely different. Therefore, information should be relied upon only when coordinated with professional tax and financial advice. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any insurance or securities products and services. Written and published by Liberty Publishing, Inc. Copyright © 2013 Liberty Publishing, Inc. INLJ2UU-04
The information provided is not written or intended as specific tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. MassMutual, its employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.
Insurance products issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001 and its subsidiaries C.M. Life Insurance Company and MML Bay State Life Insurance Company, Enfield, CT 06082.