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## How Much Life Insurance Do I Need?

Calculating the amount of life insurance you need is a lot like planning for your retirement. You need to figure out your financial goals, calculate how much income is necessary for those goals then figure out how much money you need to make that income happen.

Please note: this only applies to term insurance. Universal insurance (which I don’t recommend by the way) is an entirely different product. Term insurance is insurance where you pay a monthly or annual premium for an amount of insurance for a set amount of time which will be paid into your beneficiary if you die. For example someone might buy \$250,000 of insurance which is valid for ten years. If they die within those ten years then the \$250k will be paid to the beneficiary or the estate.

### Calculate how much life insurance you need

I’ll use myself as the example on this calculation. My wife doesn’t work and we decided that our goal for life insurance was to get enough to ensure that she wouldn’t have to work again. This doesn’t mean retiring in luxury but making enough money to pay the bills and hopefully have a similar standard of living to what we have now.

### Annual Living Expenses

First thing to do is figure out how much money is needed to maintain our current lifestyle. We kept track of our expenses for the first six months of this year and determined that our basic living expenses are about \$32,000 per year. This does not include mortgage payments or any other debt payments since they will be paid off with the insurance. Since the plan is for my wife not to work and she won’t qualify for any government pensions for quite a few years we need enough insurance to be able to pay off our debts and then generate \$32k net income per year which is about \$35k gross assuming a portion will be coming from Canadian dividend stocks. I’m assuming that any of the \$32k in expenses that are because of me, will be able to cover expenses for our one child. If you have more kids then you might want to increase the annual amount to compensate for this.

### Required Portfolio Size for self-insurance

How much do you need to generate \$35k per year? The normal figure for retirement planning is to use the 4% rule. I think for this purpose assuming that you can take 5% of a portfolio is safe enough that you won’t run out of money. So therefore \$35k is 5% of \$700,000. We need enough insurance to make sure that we end up with a portfolio of \$700k and no debts. If my wife worked then I would subtract her income from the \$35k amount.

Currently we already have a portfolio of \$230k and our debts are about \$200k.

Therefore: insurance needs = final portfolio amount + debt – current portfolio = \$700k + \$200k – \$230k = \$670,000. In fact I have about \$750,000 of insurance which is too much.

Summary:

1. Calculate a gross income desired according to your financial goals. Use taxtips.ca for guidance regarding taxation amounts.
2. Use the following formula: insurance amount = (gross income desired – survivor income) / 0.05 + total debt – current portfolio.

A couple of points. I use the divisor of 0.05 but if you want to be more conservative then use 0.04 (4% rule).

I’m assuming in my example that the beneficiary is reasonably young and won’t collect any type of pension for a long time. If the survivor will be older ie 50+ then you might want to increase the divisor to 0.06 because they will be eligible for government pensions which will eventually reduce the amount of insurance income necessary.

When I talk about taking 4% rule or 5% rule this refers only to the amount of money withdrawn from the portfolio in the first year. Every year after that is the initial amount adjusted for inflation. Ie in the example above, the withdrawal in the first year is \$37k. If inflation is 3% then the withdrawal in the second year is \$37k + 3% = \$38,110. In the third year you would take \$38,110 = 3% = \$39,250.

You’ll notice that two of the main factors in determining the amount of insurance needed are current debt and current portfolio value. Because of this there is no point in stressing out about the perfect amount of insurance to get because that ideal amount will change every year. This is why you don’t want to get too much insurance – more about that tomorrow. Generally speaking if your debt is going down and your investment portfolio is going up then your insurance needs are going down so if you buy too much insurance today, then in a few years you will have way too much insurance.

Another thing to avoid is to have too much insurance for too long. You might need \$750k or even a million dollars according to your plan but you probably don’t need it for 20 or 30 years. Try to figure out how long you need this insurance for and buy accordingly. In my case I bought \$500k for 10 years (plus \$250k I already had from a group plan) and after that I might only need \$250k for about another 5 years or so. Once I’m retired or close to it (hopefully in about 15 years) then I won’t need any insurance at all because our debts should be zero and our investment portfolio will provide all the necessary income.

Why Over Insuring Is Like Buying Lottery Tickets.

Senior Term Life Insurance

Categories

## Baby Expense X

The post is part of the Baby Expenses Series. See the entire series here.

Life insurance:

Once you have a baby then your life insurance needs will probably increase. Obviously you don’t need to have a baby before getting life insurance but it’s a pretty typical time for people to start thinking about it. I have a couple of posts planned on this topic which will go through the calculations that I went through for my own life insurance. I would suggest that you don’t delay getting this because it can take quite a while from the time you call an insurance company to the time you get covered – probably one month minimum. Just get term insurance, universal or whole life insurance is not worth it.

When – start working on it once you know you are pregnant. If Dad kicks the bucket before the baby is born then the need for life insurance is still there.

Cost – depends on how much you have and how long and how old you are and your health etc etc. For someone in good health in their 30’s you can get \$250k for about \$20/month.

Hospital rooms and parking:

At our hospital shared rooms cost \$205 per night which was covered by my work benefits. Private rooms cost \$45 more and we elected to pay the extra cost. Because it was fairly busy when we had our baby, there were no private rooms available the first night but for the second and third night we got a private room. Phone calls were \$2 each and we just noticed that we got charged \$16 for something called a “birth journal” which we never got.

Parking cost us around \$18 per day which is quite a bit so you have to consider this as well. This might be dependent on the region, I was recently at a hospital in a smaller city and the parking was only \$3 which is pretty insignificant. Another cost is food, our hospital had a fairly good cafeteria with reasonable prices but it’s probably more money then you would have spent on food at home.

One note on the room costs and parking – don’t assume you will be in the hospital for just one night. If you are planning a regular birth then they will probably tell you that it’s one night, however if anything changes or there are any kind of irregular readings then they will make you stay longer. I have several friends who ended up staying in the hospital for 5-7 nights because of irregular test results – the babies ended up not having anything wrong with them but the doctors are very cautious with newborns. In our case we ended up getting a C-Section which meant a mandatory three day stay. I have to say that I didn’t mind being in there for three days because you have the benefit of the nurses when you run into problems. Usually the first 24 hours, the baby is sleeping most of the time and relatively quiet and you will start thinking that this isn’t so hard. Then the screaming begins… 🙂

Pre-Natal Courses:

My wife and I took two courses – one was a course on the actual birthing experience (labour) and the other was about how to care for a newborn child. I had been told by numerous friends that these courses were a complete waste of time and sure enough they were. I don’t remember the exact costs but I think they were about \$180 per couple for each course.

The birth course is a waste of time because your actual experience will probably not resemble the “normal” experience. The other thing is that when you have a baby, you don’t have to know anything – the doctors, nurses etc will tell you what to do and when to do it.

The child caring course was a bit better but the one thing I wanted to learn from it was how to change a diaper and they didn’t cover it.

Books:

Most expectant parents will buy a book or two and pregancy, labour and caring for a newborn. This is a worthwhile effort but I would suggest not reading too many books since (like finance books) they are often contradictory. Try to borrow books from friends or sign them out from the library. We read “What to Expect When Expecting” and thought it was pretty good.

Tomorrow I’ll finish off the baby theme week with a post about RESPs.

Next Baby Expense post.

Previous Baby Expense post.