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Life insurance is something that no one really wants to think about using. While it is designed to protect you against the only thing in life that is guaranteed, the thought of preparing for a time when you will no longer be in the picture can be morbid and awkward.
Because life insurance is a very difficult part of the financial planning process to discuss, it is natural to want to select a policy and a death benefit without really having to get too personal.This is why many agents and financial experts suggest straightforward ways to help their clients assess their life insurance needs and select policies.
Agents who do not sit down and go line by line with you to cover all of the expenses you need to protect your family against may suggest a more simplified approach to choosing a death benefit.
This simplified approach is often referred to as the rule of thumb in the life insurance industry.
This rule of thumb is what a majority of life insurance agents will follow when recommending a product to prospective clients who have no clue how much coverage they actually need.
If you are about to start financial planning for the future, creating a comprehensive life insurance portfolio can be difficult.
Your portfolio needs to include enough short-term and long-term coverage that is going to help your family cover debts, immediate expenses and the need to replace income for a specified period of time.
An industry standard may give you a starting point to consider, but using this standard may insinuate that insurance is one-size-fits-all.
Read on and learn not only what the rule of thumb states, but also alternative methods that will help you select a death benefit. And be sure to use the FREE insurance quote tool at the top of the page!
What is the industry rule of thumb?
Calculating how much life insurance that you really need requires a lot of forward-thinking.
You will need to consider your current situation and picture what your needs might look like in 10 to 20 years to be realistic about your needs.
Because many people live in the now, many consultants and advisers will recommend that you purchase a policy that is 7 to 10 times your annual salary.
This general rule of thumb may not be precise, but it is seen as a starting point for people who have no idea where to start.
What are drawbacks of the rule of thumb?
The biggest problem with the rule of thumb is that this generic rule takes nothing about your current situation into account.
A single individual who is planning to one day marry who makes $50,000 per year may not need as much coverage as a married mother of two who earns $40,000 a year.
While the single individual has less of a need, if each party followed the rule the married mother of two would carry less coverage. Obviously, the rule does not work in many scenarios because it is not tailored to meet your needs.
Another drawback of the rule is that the rule itself does not take the future into account. Your current earnings can change at any given time if you are promoted or you land another job.
If you followed the rule, when these earnings changed you would automatically need to raise your death benefit.
Since raising your death benefit will mean that you need to apply and medically qualify, you could be at-risk of not qualifying for the additional coverage that you need when your salary goes up.
Not only are you at-risk of not medically qualifying for coverage, you are also putting your family at risk by choosing to under-insured.
If you recently bought a home, you need to decide if you want your policy to provide coverage to payoff that home when you are gone.
If you have a stay-at-home spouse, you may need to provide replacement income for longer than you would if your spouse was the breadwinner.
There are so many different what-if’s that you have to keep in mind and the rule of thumb just does not factor these what-if’s into the formula.
What are alternative methods to calculating how much insurance to buy?
There are all types of life insurance calculators on the world wide web that you can use for free to assess your needs quickly. Some of the calculators ask for very basic information and others will dive deeper to assess your current and future needs.
You can use a calculator or you can start to calculate your need for coverage on your own. Here are some tips on the best methods to choosing an accurate life insurance amount.
The Family Needs Approach
If your goals if for your family to be able to have the same quality of life and to live comfortably, the family need approach is the best way for you to figure out how much insurance is enough insurance.
This method helps you consider all of the expenses you will need to cover to meet all of the financial obligations your family will need to cover once you pass.
You will need to start the calculation by determining what the immediate needs will be when you pass. Immediate needs consist of money for debts, medical expenses, final expenses, estate taxes, emergency funds, and higher education costs.
After you total this amount, the next step will be to calculate the ongoing income that is needed so that your spouse and dependents can cover expenses for foods, clothing, transportation, shelter and other regular expenses.
The income that you provide will change if you are close to retirement or if you will be paying off the mortgage instead of providing long-term income replacement. This calculation will also need to include the retirement income you want to give your spouse.
Once you add these together, the last category you will need to tally up is special funding needs. These are only relevant if you have a business, you want to fund a buy-sell agreement, or a cause you want to donate to.
After you have added everything together, you then need to subtract the assets that will cover some of these needs. These assets include: savings, investments, retirement assets, and current life insurance policies in force.
Using a Life Insurance Calculator
If you do not want to do all of these calculations on your own, it can be helpful to use a calculator to estimates all of the expenses for you. With these calculators, you can just plug in the numbers and all of the math is done for you in an instant.
Once of the great things about technology is that it is able to ask you the hard-hitting questions before recommending a death benefit. Be sure that you are realistic with final expense costs and your estimation of current debt so that you have a good estimate.
What if you cannot afford a policy that suits your needs?
Did you know that a majority of people who are living without any form of individual life insurance have chosen to live at-risk because they believe that the coverage is too expensive?
A majority of these people are actually overestimating how much insurance costs, but if you truly cannot afford the amount of insurance that is recommended, it is best to get a minimal policy to begin with so that you still have some protection.
One of the biggest reasons why buying insurance now rather than later is because you never know when you might be diagnosed with an illness.
Because you are just one doctor visit away from not qualifying for a life insurance plan, applying today can really save the day.
If you purchase a policy that has a guaranteed insurability rider, you will be able to increase your death benefit limits even if you have a medical condition.
If you have a waiver or premium rider on the policy for just a few dollars, you can rest assured that the company will waive your premiums if you are declared disabled and unable to work.
You will need to choose between a permanent and a term insurance plan. Permanent insurance is generally a bit pricey for those on a budget.
If permanent insurance is part of the financial plan, buy a term insurance plan that can convert to a permanent plan so that you have protection and you still have the option to get a plan with an investment component.
As you can see, the rule of thumb is a very generic formula that is not always applicable to everyone who needs coverage. If you want to build a portfolio that really meets your needs, it is best to take a more precise approach to do more thorough calculations.
Using our FREE online rating tool can help you price the cost of insurance so you know what you can afford and how much life coverage is best.