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In most cases, if you have no dependents and have
enough money to pay your final expenses, you don’t need any life
insurance.
However, if you want to create an inheritance or make a charitable
contribution, you should buy enough life insurance to achieve those
goals.
If you have dependents, you should buy enough life insurance so that,
when combined with other sources of income, it will replace the income
you now generate for them, plus enough to offset any additional expenses
they will incur replacing services you currently provide (for example,
if you do the taxes for your family, the survivors might have to hire a
professional tax preparer). Also, your family might need extra money to
make some changes after you die. For example, they may want to relocate,
or your spouse may need to go back to school to be in a better position
to help support the family.
Most families have some sources of post-death income besides life
insurance. The most common source is
Social
Security survivors’ benefits. Many also have life insurance through
an employer plan, and some from other affiliations, such as an
association they belong to or a credit card. Although these sources
might provide a significant income, it is rarely enough.
A multiple of salary?
Many pundits recommend buying life insurance equal to a multiple of your
salary. For example, one advice columnist recommends buying insurance
equal to 20 times your salary before taxes. She chose 20 because, if the
benefit is invested in bonds that pay 5 percent interest, it would
produce an amount equal to your salary at death, so the survivors could
live off the interest and wouldn’t have to “invade” the principal.
However, this simplistic formula implicitly assumes no inflation and
that one could assemble a bond portfolio that, after expenses, would
provide a 5 percent interest stream every year. But assuming inflation
is 3 percent per year, the purchasing power of a gross income of $50,000
would drop to about $38,300 in the 10th year. To avoid this income
drop-off, the survivors would have to tap into the principal each year.
And if they did, they’d run out of money in the 16th year.
The “multiple of salary” approach also ignores other sources of income,
such as Social Security survivors’ benefits. These benefits can be
substantial. For example, for a person who had been earning a $36,000
salary at death ($3000 a month), maximum Social Security survivors’
monthly income benefits for a spouse and two children under age 18 could
be about $2,300 per month, and this amount would increase each year to
match inflation. (It drops when there is only a spouse and one child
under 18, and stops completely when there are no children under 18
remaining in the household. Also, the surviving spouse’s benefit would
be reduced if the spouse earns income over a certain limit.)
In this example, the survivors would need life insurance to replace only
$700 per month (adjusted for inflation) of lost income; Social Security
would provide the rest. These survivors would need life insurance to
replace about $1,150 per month (adjusted for inflation) once the
nonworking surviving spouse has only one child under 18 in her care, and
the surviving nonworking spouse would have to replace the entire $3,000
(adjusted for inflation) when the youngest child turns 18.
©
Insurance Information Institute,
Inc. - ALL RIGHTS RESERVED
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