Nov 23

As a rule of thumb, figure you need about $100,000 in insurance for every $500 of monthly income required. Let’s say your household needs $3,000 a month to cover all your expenses. Your worst-case scenario is that the people who survive you have no employment or other income, so they’ll need the full $3,000. You’d divide this by $500 and get 6, so your insurance policy should be in the amount of 6 x $100,000, or $600,000. The following table shows you the simple calculation. You can plug in your own numbers in the blanks at the right.
How does this work? You want your insurance payment to be a sum of money that your beneficiaries can invest to generate enough income to cover your expenses without dipping into the principal. If your monthly expenses are $3,000, that’s $36,000 a year. Assuming a conservative interest rate of 6 percent, you would need $600,000 to produce that $36,000 a year. That principal would go on throwing off income forever because your survivors are using only the interest.
Okay, that’s the worst case—but now let’s say that if something happened to you, you know you or your spouse would keep working anyway. All you need from the insurance proceeds, before taxes, is $1,500 a month. You have three choices. You can purchase the minimum amount of insurance needed to cover that shortage of $1,500 a month, which is $300,000 worth of insurance: $1,500 divided by 500 is 3; 3 times $100,000 is $300,000. Or you can purchase $600,000 worth of insurance to cover yourself completely, in case at some later date you won’t be able to work after all. Or you can purchase any amount in between that would make you feel comfortable.
Let’s say you and your spouse decided to be completely secure and bought the $600,000. Your spouse dies, but you still want to work; for now, all you need is $1,500 a month from the death benefit to cover all your expenses. What do you do with the $600,000? You will want to invest enough safely for the principal to generate that $1,500 a month in interest every year, without touching the principal, and invest the rest for growth in case the day comes when you can’t work any more or you lose your job. Let’s figure again. How much needs to be invested for income, to cover the $1,500 a month you need, and how much for growth?