How much life insurance do I need?

With a strong financial plan in place, the only things that might get in the way are those unforeseen events—things like illness, injury, or death.

While it may not protect against these events, life insurance is there to provide should they occur. The key question to ask yourself is “what would happen to my family if I were to pass away?”

You want them to be covered.

You shouldn’t have to worry whether your family will be taken care of in the future. Contact Liston Newton Advisory today for a free personal insurance strategy session, and get peace of mind.

So, how much life insurance do I need?

How much life insurance cover you should put in place depends on a number of key factors.

Your life stage

Along with your age, what you earn, your savings, your accumulated assets, and how much you spend will all change over the years. And, together, they’ll all impact your level of cover.

Typically when you’re older, you’ll have more assets and accumulated wealth, so your family will be less reliant on your life insurance. As such, you’ll need less cover.

But if you’re younger, or the sole provider of a family, you’ll likely have less saved, so you’ll need a higher degree of life insurance cover.

Your budget

The amount of life insurance cover you choose determines the amount your premiums are, so your current and future budget takes a part in how much coverage you’ll receive. A high level of cover means higher premiums—can your family afford it?

Your level of debt

One thing many people have in the back of their minds is that they don’t want to leave their families with high levels of debt if they pass away. So the amount of debt that you have will also affect your level of life insurance cover.

As such, most people try and extinguish as much of their debt as possible. Things like credit card debt, home loans, car loans, and any other types of loans.

Will your partner continue working?

Some families want to give their partner the option to not have to work again, should they pass away. For others, the partner may want to continue working, but be looking for extra help around the house.

It’s important that couples have this discussion to determine the level of payout that will allow for these circumstances.

The life you want your family to have

When looking at life insurance cover calculations, you also need to take into consideration the lifestyle your family will have if you pass away.

Where will the kids go to school? Can they still afford to live in the family home?

You need to think about the impact that your loss of income will have on the family, whether you’re the main breadwinner or not. In some cases, it may be possible to substitute some, or all, of your income with a lump sum payout—if you invest it correctly.

Let’s look at an example. Say you earn $100,000 a year. If your family gets a $2 million payout on your (untimely) death, you could invest this in assets that earn a 5% annual return. Then your family would earn $100,000 each year, which they could put towards school fees, mortgages, and everything else they need to live their lives.

Your current wealth position

Your current wealth position has a big impact on how much cover you need.

If you don’t have much in the way of savings or investments, you’ll need a higher level of cover to look after your family. Conversely, if you’ve got a high level of savings, a healthy super balance, and minimal debt, you’re likely to need less cover. Your super balance can be paid to your spouse or family upon your death, too, which will always help.

Typically, you’re looking to grow your wealth over the years, which means your level of life insurance cover can reduce. Your family can rely on more of its savings instead.

How to calculate life insurance cover

Let’s look at a step-by-step example of how to determine your life insurance cover.

Tim and Sally are a married couple, both 35 years old. Tim works full-time and earns $120,000 per year. Sally works part-time and earns $50,000 per year. They have two kids aged 7 and 3.

In this example we’ll look at cover for the main breadwinner, Tim.

Step 1: Net Asset Position

They have a house valued at $1 million, and a debt of $600,000 left on the property. They also have an investment property valued at $700,000, with $500,000 of debt against it. This gives them a total of $1.1 million in debt.

Tim has $300,000 in his super, Sally has $100,000.

Step 2: What happens if Tim passes away?

If Tim passes away, the family finds itself $1.1 million in debt, and missing $120,000 per year in income.

Step 3: Would Sally keep working?

Sally feels she wouldn’t want to work anymore if Tim passed away, and would look after the kids full time. So they would lose her $50,000 income.

But if their debt was cleared, they might not need to replace both sets of income.

Step 4: What sort of life do they want for the family?

Both want their kids to go to good schools, which they estimate to cost $30,000 per year in the future. They want the family to still be able to go on holidays, which is usually $10,000 each year.

After discussing their lifestyle, they decide Sally should have $100,000 of income each year.

With no debt against it, their investment property can generate $30,000 per year in rental income. So to achieve $100,000 in income, they need to generate an extra $70,000 per year.

Step 5: Determine the necessary lump sum payment

As a rough guide, to generate $70,000 per year in income, you would need to invest approximately $1.75 million at 4% income return.

If Tim passes away, their estate plan says that Sally can access Tim's $300,000 in super. This means they need another $1.45 million to reach a $1.75 million lump sum to invest.

They need $1.1 million to extinguish all their existing debt.

So the total lump sum payment needed is $2.85 million.

Step 6: Discuss if this is appropriate

Once they calculate the $2.85 million lump sum, Tim and Sally will discuss if it’s appropriate, and if they need to make changes to the plan.

For example, if Sally kept working, they only need an extra $50,000 income, as Sally would earn the other $50,000. This would reduce the life insurance amount needed.

They could also decide to keep some debt on the investment property, which would again reduce the insurance needed.

Step 7: Review cover every year

The mistake many people make is not reviewing their insurance cover each year.

It’s always best to review your insurance annually, to update any calculations based on your current situation.

For example, if Tim and Sally have paid down debt over the year, they can decrease their cover. If Tim’s super grows, their cover can also decrease. If they’ve taken on more debt, their cover may need to increase.

The final word

Life insurance calculations are complex. There’s a lot to consider, and many things you might miss.

So it’s crucial to engage a trusted adviser to help you perform the right calculations, so you can determine the right level of cover for you or your partner. It’s going to save you time, money, and—ultimately—save you heartache.

When a good insurance plan is incorporated with a good financial plan, your family will enjoy the life you want them to—regardless of what happens to you.