How much term life insurance do I need?
One of the first questions people ask when they think about life insurance is ‘how much term life insurance do I need?’ However, before you make an estimate, consider if you actually need this insurance. If you have a family or other dependents, and little in the way of savings and investments, you definitely need life insurance. To protect your loved ones should the worst happen to you. So, how much term life insurance do you need?
A simple, step-by-step calculation
Working out the amount of insurance you need is a pretty straightforward calculation. If you were to pass away tomorrow your loved ones would be faced with some or all of the following financial challenges:
- Mortgages and other large debts
- Funeral related expenses
- Replacing your lost income
- Education costs
You can use these categories to calculate how much life insurance you should buy. The calculation isn’t an exact science. However, it’s better to estimate the cover you need rather than make a rough guess. And then buy too much insurance. As you do the calculation, think about the lifestyle you would like your family to have.
Mortgages and debts
Add up your mortgages and any other large debts such as car loans and student loans. Your spouse may decide not to pay off the mortgage in the event of your death. But it’s better to give them the safety net of not having to sell the family home if finances are tight.
Funeral related expenses average between €7,500 and €15,000. If you don’t have funds to pay for these, include a figure for them in your estimate. Good life insurance cover will help your spouse to access funds to pay for a funeral quicker than waiting for the settlement of the will.
Replacing your lost income
You need enough life insurance to ensure that your spouse can invest the lump sum and generate the desired income after tax. Remember that you don't need to replace all of your income. Cover for 50% of your pre-tax earnings may be enough. So how do you calculate the lump sum to insure for?
Let's say you want enough insurance cover to generate an income of €50,000 from the lump sum your beneficiary receives. To calculate the coverage amount you need divide €50,000 by 0.04. This equates to a lump sum €1,250,000. The figure 0.04 represents the benefit your life insurance is expected to earn each year, i.e. 4%. It’s a conservative approximation. You can then adjust this figure according to your personal circumstances. If you are currently spending more than you earn you may wish to increase the amount of life cover you purchase. If you are saving money each month you could reduce your cover accordingly. Use your bank statements to check how much you spend each month.
Private school fees and university tuition costs vary considerably and typically increase by 5-10% each year. Well above inflation. To estimate how much term life insurance you need for your children’s education, find out the current fees for the schools and universities you are considering. Then multiply these fees by the number of years you expect your children to attend. Last, adjust for average fees rises.
Bear in mind that you could cover yourself for a proportion of your children’s education fees.
How much term life insurance you need
Now add up the amount of term life insurance cover you estimated for each category above. This will give you a total figure for the insurance cover you need. You can adjust this figure according to your personal and financial circumstances. For example, you may increase the amount if you have little or no pension provision. Or reduce the insurance cover if your spouse earns a healthy salary. Also, think about any medium-term saving goals you have, such as a new car. Increase your cover if you don’t have funds put aside for this.
Whatever figure you arrive at, it’s preferable to making an educated guess. Or using a rule of thumb such as purchasing 10 times your annual income in cover. These methods are too simplistic and don’t take account of your individual situation. In any case, your term life insurance needs will change. Although it’s rarely a good idea to delay getting life insurance cover for this reason. The older you get, the more expensive cover tends to be. And remember, some life insurance is better than no insurance.
Review your life insurance cover regularly
You can review your life insurance cover in future. In fact, it’s a good idea to do so. Life events such as home ownership, marriage, children, education expenses, and retirement will impact on the cover you need.