Let me teach you a quick trick I commonly use to calculate how much life insurance my clients need.
(Annual Income Needed) divided by .05
So if you make $70,000 per year, and need to know how much life insurance is needed to generate a $70,000 income to your spouse upon your death, the calculation looks like this.
$70,000 / .05 = $1,400,000 — You need 1.4 Million
With 1.4 Million coverage, your spouse could take the death benefit and invest it. If your spouse can earn on average 5%, it will generate $70,000 every year, and he or she could live off of the interest.
Other Income Replacement Calculations
Income Per Year Needed Amount of Life Insurance Needed
Please note with this method, your spouse could theoretically live off the interest without the principal ever depleting. I realize this may sound a bit excessive to some people, so if you want to calculate how much life insurance is needed to replace your income for a fixed number of years, such as for 10 or 20 years, please use our life insurance calculator.
Now, I realize 5% is a bit optimistic for where interest rates are current day, but I’m talking an average over a long period of time. If you want to calculate a more conservative current interest rate, divide the annual income needed by .03 or .04.
What about Investments, Funeral Expenses, and Mortgage?
I realize some of you may have retirement funds, pension money, or other insurance to factor in. If that’s the case, simply subtract the amount of liquid assets available upon your death from the amount of life insurance needed.
Perhaps you’re trying to accomplish a different goal than replacing income, such as paying for funeral expenses, paying of debt, or a home mortgage. This gets a bit complicated, and I don’t think there’s any objective way to calculate the exact amount any person needs.
A simple rule of thumb here, though, is to add up the bills you want paid off, and then use the chart above to calculate how much additional life insurance would be needed for income replacement. Obviously, if you leave your spouse with no debt and no mortgage payment, the amount he or she will need per year to replace your income is lower.
Adjusting Life Insurance Needs for Inflation
Inflation puts a wrench in things. If you desire to provide a guaranteed income stream for life, obviously the longer that income stream stays fixed, the less buying power that money will have.
The simple way to adjust your life insurance need, using the first calculation we learned, is to subtract the inflation rate you expect from the interest rate you expect to earn. So if you think your beneficiary can earn 5%, but inflation will be 2.5%, then you will only net 2.5%, and that’s the number to use in your calculation. Using our $70,000 income need:
$70,000 / .025 = $2,800,000 life insurance needed (adjusted for inflation)
If you need life insurance to accomplish a specific goal that’s not covered above, such as key man life insurance or life insurance to pay estate taxes, it’s best to give us a call for an individualized needs assessment. 877-996-9383
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