Farm Insurance Australia :: Articles

Life Insurance: How much is enough?

Life Insurance: How much is enough?

When considering life insurance, you're planning and preparing for an event that most of us would rather not think about.
But life insurance represents a critical step in managing your personal finances and ensuring your family's well-being.

The Two Approaches to Setting Life Insurance Policy Amounts

You can use one of two approaches to estimate how much life insurance you should buy: the needs approach or the replacement-income approach.
Using the needs approach, you calculate the amount of life insurance necessary to cover your family's financial needs if you die.
Using the replacement-income approach, you calculate the amount of life insurance you need to equal the income your family will lose. Let's look briefly at each approach.

You need how much?

Insuring your most valuable asset
While many people would consider their home or their car to be their most valuable asset, it's your ability to earn an income that is most important in shaping your financial future. Statistically, two thirds of working Australians will suffer an injury or illness that will sideline them for 90 days or more. The majority of these people would not be able to pay their mortgage or meet car finance and other loan commitments without adequate income insurance.
Using the needs approach, you add up the amounts that represent all the needs your family will have after your death, including funeral and burial costs, uninsured medical expenses, and estate taxes.
However, your family depends on you to pay for other needs, such as your child's college tuition, business or personal debts, and food and housing expenses over time.
The needs approach is somewhat limiting.
The task of identifying and tallying family needs is difficult, and separating the true needs of your family from what you want for them is often impossible.

Replacing Income

Using the replacement-income approach for estimating life insurance requirements, you calculate the life insurance proceeds that would replace your earnings over a specified number of years after your death.
Life insurance companies sometimes approximate your replacement income at four or five times your annual income.
A more precise estimation considers the actual amount your family members need annually, the number of years for which they will need this amount, and the interest rate your family will earn on the life insurance proceeds, as well as inflation over the years during which your family draws on the life insurance proceeds.

Note:

Do remember, as you quantify the income you want to replace, that Social Security provides generous survivors benefits if you've qualified.

Calculating Replacement-Income Amounts with Excel

If you've got access to a computer running Microsoft Excel, the popular spreadsheet program, you can use your computer to calculate the amount of insurance you need to replace a specified number of years of income.
Suppose, for example, that you want to buy enough life insurance to replace the income from a $50,000-a-year job for 15 years.
If you figure your family will earn 5% on the life insurance proceeds should the worst case scenario occur, you enter the following formula into a cell in an Excel workbook to calculate the replacement income life insurance amount:
=-PV(5%,15,50000)
Excel returns the formula result 518,982.90 indicating that you would need roughly $520,000 of life insurance, invested at 5%, to payout $50,000 a year for 15 years.

Two Calculation Tips

If you want to factor in inflation because you're trying to replace income over a long period of time, you should use a real rate of return rather a regular, or nominal, rate of return.
To calculate a real rate of return, subtract the inflation rate from the interest rate in the formula.
For example, if you expect 2% inflation, you could replace the formula shown earlier with this formula:
=-PV(5%-2%,15,50000)
Here's a final calculation tip:
You probably want to round up your number. For example, if the formula provided earlier returns the value 518982.90, you might want to round up this value to $600,000. Or $750,000.

Editor's Note:

Financial Services Online provides a free online calculator that uses a combination of replacing income and needs approach in helping to determine the amount of life insurance cover you may need.
Truck Loans
If you are in the market for a commercial vehicle, then we're in the market to help you arrange the money. Our truck loan & leasing service is backed by a national panel of truck loan specialists who will establish your eligibility, find lender/s offering the best deals for your situation … and help you through the approval and settlement process. No charge to you … and no obligation to proceed with any recommendations offered.
Business Insurance Renewal Due?
If you are in the process of renewing your business, public liability or professional indemnity insurance ... whether it be a professional, trade, manufacturing or retail business ... we can show you a quick way through the maze of offers and options available on the market. Our Australia-wide broker panel will ensure that you get the best cover for your specific needs - and at the right price to suit your budget.


Insurance Articles

Why life insurance is a necessity in tough times Why life insurance is a necessity in tough times
With household budgets under pressure ... and consumer confidence weak, many families are wondering whether life insurance is worth the expense. Or maybe it is something they can do without? - read more
Insurance: The Absolute Basics Insurance: The Absolute Basics
Insurance has often been considered by many as a necessary evil. But for the majority of people, insurance offers real security, peace of mind and forms a fundamental platform for a more certain financial future. Understanding the basics of insurance and how it works will be enlightening for many. - read more
DIY Review Checklist for your Income Protection Insurance DIY Review Checklist for your Income Protection Insurance
If you have an income protection insurance plan already - or are thinking about buying one, then you need to be aware that these policies require regular maintenance and careful scrutiny to ensure that they adequately meet your needs. Unfortunately, many people purchase income protection insurance policies only to find out about their shortcomings at claim time. - read more
Types of Insurance Policies Every Business Owner Should Consider Types of Insurance Policies Every Business Owner Should Consider
Protecting business investment with insurance is a critical part of every sensible business owner's business plan. Insurance protects businesses from unexpected financial risks due to natural disasters, accidents, liabilities and losses, which may run in to thousands. - read more
Business: Avoiding Loss with Proper Risk Management Strategies Business: Avoiding Loss with Proper Risk Management Strategies
A Financial loss is something that no business wants to suffer - and small business owners will do their best to avoid downtime, expenses and accidents. But will insurance provide the total solution? Or is there more needed to ensure business continuity? - read more
4 Tips For Reducing Your Insurance Rates Dramatically 4 Tips For Reducing Your Insurance Rates Dramatically
There are many different ways you can save in different insurance policies. However, some things that will help you save in one policy will have no bearing whatsoever on another policy. Here are things that will help you save across all insurance policies. - read more
Top 5 Reasons to Buy Insurance Through a Broker Top 5 Reasons to Buy Insurance Through a Broker
In today's litigious and uncertain world, insurance has become a very important component of every financial plan. But, when it comes to buying insurance, consumers often get confused obout where they should start and how to decide on the best policy solution to their specific needs and circumstances. - read more
The Weird and Wonderful World of Insurance The Weird and Wonderful World of Insurance
We came across this amusing (but true) insurance story with an interesting twist. Only in America! - read more
Insurance Disputes Insurance Disputes
Just because your insurer has rejected your claim, does not necessarily mean that your case is closed. If you think that you have been unfairly treated, here are some ways to get the insurer decision overturned. - read more
Insurance Claims - The Acid Test for Insurance Policies Insurance Claims - The Acid Test for Insurance Policies
How well a company handles their processes and the customer experience at claim time is what truly determines the real worth of the insurance policies that are being sold. - read more

Insurance News

If insurance was free, would there still be an underinsurance problem?
Nov 20 :: Even if price wasnt a factor, AMPs Chris Kirby argues that Australia would still have an under-insurance problem. This is why it is the industrys job to kill preconceptions and... read more
Regulatory compulsion propels commercial insurance
Oct 26 :: Australia is the second largest advanced market in Asia for commercial insurance, not least because of regulatory requirements around issues of professional indemnity, according to... read more

Need a Quote?
Start your free farm insurance quote comparison here.
Farm Type:
Postcode:

Knowledgebase
Disability Insurance:
A type of insurance protection that pays a portion of a person's income lost due to a total or partial disablement arising from either an accident or a sickness.