Approaches to Life Insurance
Life insurance is often viewed as coverage to replace the income of the primary wage earner for a certain period of time. The coverage amount can allow the family to live comfortably for five, ten, fifteen, or even fifty years. It can also be used to cover the loss of the secondary income earner or non-working spouse. What are the impacts if the other person is not there to pick the kids up from school, to pay the bills every month, mow the lawn, buy groceries and clothes?
There are two basic methods for determining the right amount of life insurance. The first method is the needs-based approach. What is the lump sum amount needed to replace the income for the primary wage earner and meet the needs of the family? This could include death expenses, debt payments (mortgages and cars), education expenses for the children, emergency funds, income requirement, and spouse needs. All of these factors can be calculated on a weekly, monthly, or yearly basis. Then the amount of time or how long the money will last can be calculated. This lump sum amount should meet the needs of the family over the determined period of time.
The second method is the life-value approach. This can be done by simply taking the annual earnings for the individual and multiplying it with a multiple between 10 and 16. These multiples are not as precise as the needs-based approach, but can provide a rough “rule of thumb” for the average family. For instance, if you earn $60,000 a year then at a minimum you should carry $600,000 up to $960,000 of insurance. Another way to determine the life value approach is take the current earnings and add on the future growth of earnings. If we add together the current and expected earnings then we can determine the life value of earnings or that period of time.
The life value approach is a little more general and simple than the needs based approach, but both of these methods can provide a good estimate on the amount of insurance coverage required to meet their family needs in the future.
About the Author
Ross graduated from the United States Merchant Marine Academy in 2003. He joined AAFMAA in 2012 and is now the Assistant Secretary. He continues to assist members of the US Armed Forces and their families with their life insurance decisions.