How Much Is Enough?
Americans have a combined $10 trillion in life insurance coverage.1 That’s an amazing sum, but consider this: It’s only about 72% of America’s roughly $14 trillion annual income, or what economists call gross domestic product.2 Just about any family coping with the loss of a breadwinner would find it difficult to get by on a one-time payment equal to 72% of the earner’s salary.
When you look at your life insurance coverage as a lump sum, it might seem like a lot of money, but how much is it in relation to your annual income? The ideal coverage amount is undoubtedly some multiple of annual income. But how do you know how much is enough?
Quality-of-Life Considerations
An easy place to start is with an inventory of monthly expenses, such as mortgage and car payments, utilities, food, and clothing. Ideally, a death benefit would be able to meet living expenses for at least a few years, so that family members who are recovering from a tragic loss wouldn’t also have to cope with a declining standard of living.
But don’t stop there. It’s also important to consider quality-of-life issues and your family’s long-term goals.
Will the surviving parent need to work? If the answer is yes, what will it cost to care for younger children during the surviving parent’s workday? Would the children’s needs interfere with the parent’s ability to work full-time?
Will the children have funds to attend college? A single parent might have a tough time continuing contributions to the family’s college savings program or paying tuition and related costs.
Will the death benefit keep pace with inflation? It’s prudent to assume that the cost of living will grow 3% to 4% per year. If you purchased coverage many years ago, it is possible that inflation has significantly eroded the purchasing power of the death benefit.
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable.
As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications. Before you take any specific action, be sure to consult with your tax professional.
1) American Council of Life Insurers, 2008
2) Bureau of Economic Analysis, 2008
This material was written and prepared by Emerald Publications.
© 2008 Emerald Publications
Tony Ricci, CFP®
2831 Camino Del Rio South, Suite 101 • San Diego, CA • 92108
Phone: 619-297-9770, Ext. 13 • Fax: 619-297-0549