How Much Insurance To Buy?

By Author: Norris Rios
Total Articles: 572
Comment this article

One thing in life is absolutely certain. If you ask an insurance agent how much cover you should buy, the answer will always be a lot more than you ever thought of buying. When you ask this question, always remember most agents earn a commission, i.e. a percentage of the amount of cover they sell. So they always have an incentive to sell you the maximum they think you can afford on your income. This is not to say a high level of cover is not the right answer for you and your family. But it's a factor you should bear in mind when you ask for advice. In fact, there are two different ways of approaching the answer to this question. It's entirely possible they might produce similar answers, but this does not make the answers necessarily correct. We will come back to this later.

The first approach looks at the needs of your family. There's always an element of guesswork about this so most people research the costs today and then allow for inflation over time. For example, the buying power of $1 in 1960 is now represented by $7. How quickly the value of the dollar changes depends on the economy. The cost of living rises and ...
... pay has to increase to allow people to enjoy a reasonable quality of life. So you take two years as the basis of the calculation. One is optimistic, the other pessimistic. Find out how much it costs for a funeral and the other fees and charges payable on death. Remember there may be uninsured medical expenses and other personal debts and, depending on your asset holdings, estate taxes to pay. Now, if you take the pessimistic date, your family may still be young and their needs may be great, including some big ticket items like paying your children's way through college. In theory, you are only assessing their needs but it's difficult to avoid thinking about to make their lives better in difficult circumstances. If you take the optimistic view, your family have all flown the nest and the needs of your spouse will be relatively modest. Now the unknown is the extent of the provision you might want to make for the rest of the family.

The second approach simply looks to replace the income you represent. This assumes your family will be well provided for if they receive a multiple of your gross pay as a lump sum. Advisors differ but most assume between five and seven years is a good starting point. The problem here is that the family may have been struggling on your pay and would only get out from under the pile of debts if you adopt a needs approach, i.e. you take a hard look at what they are actually likely to need rather than assume they will cope. And all of this has to be tempered by what you can realistically afford. The best approach may be to buy a smaller policy now and review the extent of the life insurance cover you think best as circumstances change. The only problem with this approach is a change in your health may cause the life insurance company to refuse to sell additional cover.