Many advisors ask me, how much life insurance should does my client need? My answer is almost always, well, how much do they WANT? Buying life insurance is a very personal decisions and the biggest question you should be asking your client is what would you WANT to happy if you died yesterday.
Most life insurance agents and financial advisors are trained based on the 'Needs Analysis' approach.
The needs approach is a method used to calculate the amount of life insurance that an individual or a family needs to cover their necessities. The needs approach is a function of two variables: how much money is necessary at the time of death to meet obligations and how much future income is needed to sustain the household without falling into poverty. Source: Insuranceopedia
This approach requires a fact finder with a myriad of assumptions (age, income, expense, current savings, retirement age, etc.). They take this information and put it through software program to tell your life insurance shortfall.
Another approach is the multiple of income. If you can earn 5% on your assets, then a death benefit of 20 x income will be enough to fully replace the loss of income at death. You can adjust this figure by current assets to get in the 10 - 15 x income range. This approach is much quicker to calculate, but may not be as accurate or personalized at the needs based approach.
The following, however, is a better way of helping the client decide how much insurance they should have.
How Much Life Insurance do I Need?
In school you learn to never answer a question with a question. When it comes to determining the appropriate amount of life insurance, I feel you should break this rule. I suggest the following question in response to the question of how much life insurance to I need:
If you passed away yesterday, what do you want for your family from a financial perspective? In other words, what lifestyle do you want them to have?
This turns the whole issue of how much life insurance someone needs into how much do you want in order to take care or YOUR family. This gets at the whole point of life insurance. It is not for you, but for the ones you love. If you want your family to have the full impact of your lost earnings power, then you should have 20 x income.
How Much Life Insurance do I Want?
If you start with the lifestyle you want for your family, you can break this down into how much income you want for your family. From there you calculate how much money (or death benefit) it would take to deliver that level of income. You can adjust this number by current savings and also any current insurance you have today.
By using this approach, you will determine the amount of coverage that makes sense for your situation. It is a personalized solution that is tailored for the financial goals you have for you and your family.
Once you and your client have determined how much insurance they want. It all comes down to their budget (how much they can spend) and what strategy and products you use. For more information you can check out our Young Professionals Strategy page.