*As published in the May 2012 issue of FinanceWorks.ca

You’ve decided to purchase a life insurance policy to protect your family but you have no idea how much coverage you need. Five hundred thousand dollars, $1 million, or even $2 million? What amount fits your situation?

There’s no easy answer. If you ask a dozen different insurance brokers, you’ll likely get a dozen different answers. Every insurer has its own insurance needs calculator and while they usually take in the same factors (your income, expenses, debt and inflation), each one will give you a slightly different answer. No matter which calculator you use, in the end your total coverage depends on what you want to leave behind. Every person has a different perception of the benefit they should provide.

The most basic life insurance needs calculator takes your annual income and multiplies it by ten. Many insurance companies use this calculation to ensure you are not over-insuring yourself. For example, if your annual income is $35,000 and you’re trying to purchase a $1.5 million life insurance policy, a red flag will be raised at the insurance company, since your coverage should match your needs.

Let’s do an example:

  • 35-year old, married man earning $75,000 per year
  • Wife earns $50,000 per year
  • Debt: $395,000 mortgage, $25,000 car loan, $9,500 owed on credit card
  • Two children: aged 6 and 4

Based on the ten times rough calculation, he should purchase a $750,000 life insurance policy. But we’re going to do a more in depth analysis of his needs:
    $429,500 for debt elimination
    $10,000 for funeral expenses
    $10,000 for uninsured medical expenses
    $100,000 for children’s education ($50k x 2)
    $168,000 for childcare expenses ($1k/mo x 14 years)
    $180,000 for wife for retirement fund (goal of $500k by 65)
    -$75,000 from work life policy
    - $2,500 from CPP death benefit

Most insurance calculators factor inflation, present value of future cash, and expected return on investment but we can simplify the calculation by removing those factors as return on investment often offsets inflation. Besides, these factors can only be estimated.

Some agents take into account the value of savings and RRSPs when calculating assets that can be used at the time of death, but this contradicts the goal of life insurance. Life insurance is meant to ensure that, financially, life continues as normal as possible. In our example, cashing in RRSPs and savings would be a set back for the man’s family. 

With the example above, this man can now go purchase an $820,000 life insurance policy knowing that he has protected his family and kept their financial goals in place. It is definitely worthwhile to sit down with a broker and discuss your insurance needs and protection goals to arrive at your personalized number. Once you’ve determined your need then you can figure out the best type(s) of insurance to utilize within your personal budget parameters.