The best way to think of life insurance is to think of it as "income protection". If you are like most families, you have become accustomed to a certain standard of living, usually dictated by the consistent income of the breadwinner in the household. In a way, the financial supporter in the family is like an ATM machine sitting in the corner of your house. If you become accustomed to taking $1000 a week out of that ATM at the beginning of the week to sustain your lifestyle wouldn't it be a good idea to insure that machine? This is the basic concept of life insurance.

There are two types of life insurance policies:

1. Term Life Insurance

2. Cash Value Life Insurance (whole life, universal life, variable life)

Term insurance is exactly what it sounds like. You pay the premium and you are covered for a certain term.

Cash value insurance works like this. A portion of your regular premium payment, roughly the amount of an equivalent term life premium, pays for your life insurance. The balance, minus management charges, is applied to your cash value savings account. To build savings, premiums are higher than term life premiums, by roughly the amount of your savings contribution.

How much life insurance is right for you?

Assume your spouse currently brings in $60,000 income per year and your family lives comfortably. You want to be able to invest a lump sum and have it pay out $60,000 of interest each year. How can you do this? One thing that you need to consider is that social security comes into play here.

Let's assume that you have two children living at home. The average surviving spouse with two children can expect to receive approximately $2,000 per month from social security. Of the $60,000 income needed in this case, social security will provide for about $24,000 a year. That means you would need to recoup about $3,000 per month ($36,000 per year). To make up for this with life insurance the coverage would have to be $600,000 (36,000/6% = $600K). The general rule of thumb on how to figure out how much life insurance you need after social security is to just multiply ten times the income needed. In this case, if you multiply ten times $60,000, you will need $600,000 worth of coverage. If the annual salary of your spouse was $30,000, you would need $300,000 worth of life insurance coverage.

This is why we stated earlier that life insurance is nothing more than "income protection". Now I know what you are thinking......can we really count on social security being there as a form of income in the future? If this is one of your concerns then all you need to do is the same calculation above without including the social security aid. To do this we take the salary (income per year needed) divide it by the interest rate (6%) and we come up with the life insurance coverage needed. In this case it would be $60,000/6% = $1,000,000. If your spouse earned an income of $30,000, then you would only need $500,000 worth of coverage ($30,000/6% = $500,000). Obviously if you feel that you need more or less income per year you can adjust the amount of coverage accordingly.

It is important to remember that different policies and coverage will be better for different people. There is no one right answer. For some, cash value in a life insurance policy makes sense. For others, they may just want to invest money elsewhere. It all depends on your financial situation and goals.

One thing is for sure though, you don't want that ATM to stop spitting out money and with life insurance premiums at all time lows, there is no better time to start doing your life insurance homework. If you have any questions, we are always here to help answer them.


Steve Scalici, CFP® is the Vice President of Treasure Coast Financial, a financial planning firm in Stuart, FL. He is co-host of God's Money which can be heard weekdays at www.oneplace.com. He can also be reached at his website www.tcfin.com.