By: Alan S. Lurty, Fellow of the Life Management Institute, Retirement Income Certified Professional, and Wealth Management Certified Professional
As a consumer, if you’ve thought about protecting your family from the unexpected with life insurance, you’ve probably wondered about how much insurance is enough, and maybe thought, "couldn’t I just get by with the life insurance I get at work?”
In short, the answer is generally no. There are several ways to determine the appropriate amount of life insurance protection for your family. The first, and most detailed, approach is to consult with a financial services professional about completing a capital needs analysis. The CNA essentially looks at current and future expenses (including one-time lump sum amounts such as a mortgage payoff and funeral expenses), income replacement requirements, and existing assets to determine the amount of insurance needed. It’s not an arduous process, but it does require one to consider the above aspects, gather information, and run the numbers (there are numerous calculators available online if you want to get a sense of this on your own).
The human life value approach looks at replacement of earnings net of taxes and living expenses. But if you’re looking for a quick rule-of-thumb approach, many experts use a guideline of 7-12 times income for each earner. However, it’s important to note that this approach doesn’t consider your own specific circumstances and needs.
The problem is that the amount of life insurance one typically gets from employment is usually far less than any of these approaches would generate. Many companies no longer provide life insurance in their benefits package. For those that do, the amount of employer-paid insurance is often only one times the employee's salary, though a few companies offer more.
Think about this: if you are only protecting your family with one time your salary and the unexpected happens, your family only has 12 months before some difficult decisions need to be made that can affect them for a very long time. My own view is that the employer-paid life insurance benefit was never intended to provide complete family protection, but rather to be a supplement to other coverage.
The benefits package of an employer who provides paid life insurance to its staff often includes a program that allows employees to “buy up” additional amounts of life insurance at the employee’s own expense. Usually the maximum buy-up is a few more multiples of salary and is capped at some maximum dollar amount. Typically, there are some limited underwriting questions that must be answered favorably in order to get the additional coverage. It’s also important to note that the cost of employer-paid life insurance in excess of $50,000 is included in the employee’s taxable income.
The buy-up can be a valuable option, but one should consider that the competitiveness of the premiums for the buy-up amounts may not be as favorable as you could get in the open marketplace, especially for someone who is relatively young and healthy. For example, a healthy 35-year-old female willing to go through the usual underwriting process can often get a significant amount of individual life insurance in the marketplace for far less than the premium charged in the buy-up program noted above.
Summary
In summary, it’s a good idea to talk to a financial services professional about the right amount of life insurance you need. I hope this helps explain the issue — please reach out on the site with any questions!
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