Choosing The Appropriate Coverage Amount
“A man’s treatment of money is the most decisive test of his character–how he makes it and how he spends it.” — James Moffatt
Once you have established that you need life insurance coverage, the next step is to determine how much your death benefit should be. The higher the amount of the death benefit, the higher the premium you will pay. To get an adequate amount of coverage at the best possible price, you want to estimate your death benefit needs based on a sensible criteria.
Depending on who you ask, the methods for determining the appropriate death benefit vary. Usually it is recommended that the yearly income seeking to be replaced is multiplied by a factor. Some recommend 8-10 times the amount of yearly income required to replace the income of the insured. Others recommend that you choose an amount that if invested conservatively would provide a continual income for as long as it is needed.
As an example, let’s assume that you contribute $50,000.00 per year in income or services to your household. If you were to die, let us further assume it would take approximately $50,000.00 per year to compensate for the financial hardship your loss creates. Deciding on the correct amount of coverage for that situation would require you deciding how many years after your death your lost contribution would need to continue.
If we assume that the financial hardship created by your loss would only last 10 years after your death, then you would multiply $50,000.00 by 10 to arrive $500,000.00 as an adequate death benefit. In a situation where the financial hardship would last for the life of the beneficiary, a death benefit amount should be selected that if invested at a conservative rate of interest would yield a yearly return of $50,000.00. For example, a $500,000.00 death benefit invested at 10% would yield $50,000.00 per year.