How much life insurance do you need? - Most people have too much. This 5-step process can help pinpoint your needs

How much life insurance do you need? - Most people have too much. This 5-step process can help pinpoint your needs
By Kimberly Lankford
Copyright © 2010, Tribune Media Services
2:07 p.m. CDT, August 12, 2010
http://www.chicagotribune.com/business/sc-cons-0812-invest-life-insurance-20100812,0,7184848.story


The purpose of life insurance is to allow your family members to pay the bills and live their lives as planned despite your absence.

Standard formulas — such as buying coverage equal to eight to ten times your annual income — are inadequate shortcuts. Online calculators are apt to tell you to raise your coverage by $1 million even if you already have insurance. The truth is that life insurance is a personal affair. Two couples may earn equal salaries, but it's silly to say that someone with four young children should have the same coverage as empty nesters with no mortgage and a substantial retirement fund.

Some experts and most online calculators sponsored by the insurance industry seek to figure the chunk of investment capital it would take to replace all of your income for 20 years or longer (held securely in Treasury or municipal bonds and certificates of deposit). But others say that rule of thumb is too generalized and might be costing you more than is necessary to secure the future.

Determining your coverage needs
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Tim Maurer, a financial planner and co-author of "The Financial Crossroads," advises to assess whether you need extra coverage or different policies only after you project your life-insurance needs as the sum of four categories.

Final expenses: A funeral, burial and related expenses tend to cost $10,000 to $20,000. Your beneficiaries may be able to get the tax-free proceeds from insurance faster than if they waited for money from your estate. Use $15,000 as a ballpark number.

Mortgages and other debts: Total your mortgage balance, car loans, student loans and any other debts that would be a heavy burden on your survivors. They may choose not to retire the mortgage, especially if the interest rate is low, but the money should be available so that they won't face the prospect of being forced to sell.

Education expenses: This calculation can be tricky because you need to consider the cost of college at the time your kids enroll. College costs have been rising by about 5 percent a year, which is the same rate Maurer conservatively expects life-insurance proceeds to grow over time. He recommends looking up current costs for colleges you're considering, deciding whether you want the insurance to cover all or a portion of the tab, and adding the amount in today's dollars to your life-insurance calculation.

Income replacement: Once you cover funeral expenses, debts and education, your family won't need to replace 100 percent of your income — and that's where the subjective part of the calculation comes in. Maurer recommends covering 50 percent of current pretax earnings until retirement. You can translate this into a target lump-sum benefit by dividing it by 0.05. For example, if you earn $100,000, divide $50,000 by 0.05, which works out to $1 million. That assumes the insurance benefits will earn 5 percent a year over the long haul, a conservative back-of-the-envelope figure.

The wild card: Once you add all four categories to estimate how much life insurance is appropriate, tweak the number to reflect personal circumstances. You might increase it if you don't have a pension, but you could decrease coverage if your spouse earns a substantial salary. If you or a family member has a troublesome medical history, add $100,000 or even $250,000. If you're the one with the medical condition, get a policy soon, as you'll find it tough to buy additional coverage later at a price you can afford.

For most families, this exercise will work out to a coverage amount in the high six-figures, possibly even $1 million or more.

Term affects cost

Term insurance: A set period of coverage that expires at the end. Boosting your death benefit by hundreds of thousands of dollars should cost just a few hundred dollars a year with term insurance. For example, a healthy 40-year-old male nonsmoker might be considering a 20-year, $500,000 term policy for $360 per year. But he could buy $850,000 of coverage for $576, or a $1 million policy for $645, says Byron Udell, owner of AccuQuote, which represents dozens of life insurers. Women pay less — just $311 per year for $500,000 in coverage and $558 for $1 million. You can get prices from dozens of companies at accuquote.com or lifequotes.com.

Permanent insurance: You keep this plan for the rest of your life regardless of health issues you may face down the line. Premiums will be higher than for term at the beginning, but they usually remain level indefinitely. You might want this if you need to protect kids with special needs who will always rely on you (or your estate) for support, or if you want to leave money to a school, charity or your children and you don't expect to afford it any other way.

Convertible-term insurance: These policies come with the right to convert to permanent life insurance. Premiums rise as you convert the coverage. One advantage of this policy is that insurers don't require a new medical exam when you make the conversions. That essentially gives you a pass if you gain weight, develop high blood pressure or even survive a bout with cancer. As long as the insurer remains strong and solvent, the policy's cash value will rise every year, as will the death benefit. Once your policy is fully converted, a portion of it can be borrowed, withdrawn or tapped to keep the policy in force without paying additional premiums.