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October 12, 2009

Life Insurance How much life insurance do you need?

That's the question we're asking today, as our latest tool is designed to put you in the right ballpark when it comes to making sure your loved ones have the resources they need to live the way they would if you were alive and providing for them.

However, we're only going to consider term life insurance for our tool. Sure, you could opt for a universal or whole life policy, or some other kind of hybrid policy, but really, when you get right down to it, all of these are just term life insurance policies that have some kind of investment vehicle attached to them, for which you still need to answer the question of "how much life insurance do you need?"

Our tool below is inspired by one that Certified Financial Planner Jeff Rose of Good Financial Cents used in his post "How Much Term Life Insurance Do You Need to Buy?" We reverse engineered the results he obtained from the tool he used for the example he considered (but for which he failed to provide a link!)

Our default numbers are the same as those he used for his example. If they don't apply to your situation, well, don't complain to us, change them!

Household Income Data
Input Data Values
How much annual income would your survivors need in the event of your death?
How much annual income do they bring into your household today?
How many years will your survivors need the income?
Household Debt and Burial Expense Data
How much total debt do you have that you would like to have paid off in the event of your death?
How much do you anticipate will be needed to cover your burial expenses?
Investing Data
Assuming your survivors will invest the death benefit from your policy, what annualized interest rate can they expect to earn? [%]
Existing Coverage Information
How much term life insurance do you have already?

Estimated Replacement Income
Approximated Results Values
Income Shortfall [Amount of Annual Income Needed to Replace Yours]
Minimum Amount of Policy Needed to Cover Replacement Income
Estimated Term Life Insurance
Estimated Death Benefit Needed to be Provided by Term Life Insurance Policy

The tricky thing about using this tool is considering the balance between income needed to support your survivors and debt payoff. For instance, if your policy provides enough to pay off all the different parts of your debt, such as your mortgage, car payments, student loans, child's college education, etc., then you likely don't need to replace the part of your income that goes to cover these things today. And vice versa - if you're replacing the income that cover your portion of the payments for all these different debts, why double up?

Beyond that, the interest rate that your benefit payout is assumed to earn through the years is where your survivors greatest risk lies. They'll need to account not just for the typical real rate of return that might be expected from where the invest the life insurance payout from your policy in the event of your death, but also the rate of inflation, so that the erosion in the value of money over time doesn't disadvantage them. Historically, the long-term average rate of inflation in the U.S. is 3.3%. These two rates should be added together to produce the interest rate used in the tool above.

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About Political Calculations

Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at:

ironman at politicalcalculations.com

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