How Much Life Insurance Do You Need?
**The following post is a guest blog from our friends at Ratehub.ca**
The truth is, there’s no “right” answer to the question of how much life insurance you need. There are various factors, including how accurate you care to be. Formulas vary:
- Simple: Generic “rules of thumb,” such as 5-10 times your annual income
- Sophisticated: Take the present value of projected cash flow shortfalls in a comprehensive financial plan
Your situation changes and requires regular review. For example, you may need less life insurance when you finish paying off your mortgage, or more if you have a new child.
Do you even need life insurance? Probably, but you may have enough coverage from work. If you’re single and debt-free, you have less of a need for it.
Tip: Don’t start with a budget. You may have an idea of how much you want to pay for insurance. Price is a consideration but there are numerous ways to save money. Start by figuring out how much life insurance you need today.
Your life insurance gap
You can calculate your life insurance gap with a basic calculator. The formula is your liabilities minus your assets. Below are a few more details.
Liabilities: Your final expenses
There are costs at death such as the funeral, legal fees, and executor fees. Where is the money going to come from? Life insurance is often a cost-effective source. As a bonus, there’s no need to dip into an emergency fund or to add debt.
Liabilities: Your debts
Financial obligations such as a mortgage or a line of credit don’t disappear if you die. Rather than leaving a financial mess, you can get life insurance to repay them to leave your family debt-free.
Liabilities: Your income lost
If you’re gone, your family loses your income. Some expenses may drop because you were part of the costs. Others will continue. Some expenses such as childcare may increase.
Since the life insurance death benefit is tax-free, look at the after-tax income your family will need to replace. Suppose that’s $30,000 a year. How long do you want this income to continue?
- 2 years: add $60,000
- 10 years: add $600,000
- 20 years: add $1,200,000
The numbers get big, fast. The good news is that term life insurance is inexpensive if you’re healthy.
Liabilities: Your gifts
You may dream of helping your children afford a university education or make a down payment on a home. You may care about a special cause, such as animal shelters. Life insurance lets you make these gifts and reduce taxes.
Assets: Your offsets
Your liabilities may be larger than you expected but your assets offset them. Typical assets include:
- Your emergency fund
- Your nonregistered savings such as mutual funds, ETFs, stocks and bonds
- Your registered savings such as TFSAs and RRSPs
- Your current life insurance, including coverage from work
Ignore assets you don’t want touched. Your emergency fund could be used for other emergencies. Savings could be earmarked to provide retirement income for your spouse.
You can now calculate your life insurance gap and start looking at prices. While life insurance is inexpensive if you’re healthy, you may still need to make compromises to fit a realistic budget.
You can get more sophisticated in calculating your insurance needs by considering factors such as:
- The rate of growth you expect on your assets
- The rate of inflation you expect
- Expected changes in your liabilities
If you’re getting life insurance for estate purposes, you’ll need to be more sophisticated to estimate how much coverage is needed at your projected time of death. To be conservative, also look at how much you might need if you live longer.
The easy way
If you want an easy way to figure out how much life insurance you need, you can consult an independent insurance advisor with access to products from different companies. Even then, having an idea of how much you need will help you decide.
RateHub.ca is an independent financial product comparison site that empowers Canadians to make smart financial decisions by comparing rates on mortgages, credit cards, chequing accounts, savings accounts, and insurance.