How to know if you have too much Insurance Coverage

The amount of life insurance you currently have is not right or wrong, it just is what it is until you compare it to what you would want it to provide for in the event you did not come home last night. This is a phrase used over and over again when helping a family determine if they have the correct amount of life insurance. The only way to know if you have too much or too little life insurance is to compare it to what you would want it to provide for should something happen.

Some people will tell you to use a specific amount determined by your salary. While this can be useful in part, it really doesn’t give you an accurate representation. There are two ways you can try to account for the amount of insurance needed. The first is more complicated but more accurate.  

The first thing to consider is the amount for burial. Normally, somewhere between $15,000-$20,000 is a safe estimate for this, but you can make this whatever you would like. The next step would be to determine the amount of all of your current debts. This includes mortgage, car loans and credit cards. Anything that you would want to be paid off assuming something were to happen.

The next thing you need to consider, if you have children, is whether or not you want to provide for their college education. You need to determine in today’s dollars the amount you want to provide each child per year and for how many years. A good way to break it down is to think $20,000 for a state school, $40,000 for a lower end private school and $60,000 for a higher end private school. So, assuming you have two children and you want to provide enough money for them for two years at a state school, then you would factor in $80,000.

The final step is to decide how much money your family needs to live on assuming all of these debts are now paid off. It is usually safe to estimate they would need between 50-75 percent of your current income. A different way to look at that step is to figure out what all of the monthly expenses would be assuming all debts are paid off; the result would be a suitable amount of coverage. Once you have this number, you then have to decide how many years you want your family to receive this money for. Some people will have it go until the spouse reaches retirement. Others have it last until all children have graduated school. How ever you go about it isn’t important, just get a number. Once this is done you need to come up with a present value of what this would be, and also factor in inflation and a rate of return. 

Just as an example: Assuming you want $3,000 a month for your family for 15 years and you assume a 6 percent rate of return and 3 percent inflation, then the number would be $479,000.

While this seems tedious and somewhat complicated (especially the present value portion) it is the best method for determining what you should have in insurance. A website developed by LIFE breaks all of this down for you. Moreover, the life insurance calculator does all the calculations for you once you answer the above questions plus a few more.

The second way to determine the amount of life insurance is more direct, but is somewhat less accurate because it doesn’t account for increases in salary and standard of living. With this method you just take you current salary and find a present value for the amount of years you would like this to continue for. This method basically assumes that your family could continue to live on the amount of money you are currently making now.

Either way, determining the amount of insurance is sometimes a difficult process. It is helpful to speak with an insurance agent that can help you with your needs. If you are ever unsure if you have the correct amount of insurance, then it is always better to go with more than less. No one will ever be upset with you for having too much insurance, but they may be upset if you have too little.