How Much Life Insurance Do You Actually Need?

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Many amongst us hate the idea of buying life insurance and consider it a waste of money. Afterall, we all hope to live a long fulfilled life and amass enough money in the interim to retire well, adequately provide for our families and perhaps leave some when the time comes. 

Unfortunately, life happens as it always does and a lot doesn’t go as planned – as the old adage goes “Man plans, and God laughs”. Essentially, there is no absolute way of knowing what lies ahead. Life is life and happens as it happens. 

Therefore, for families left behind, an adequate life insurance policy may make a great difference in their lives. Life insurance lightens the load – just a little, as it may be the only thing that is preventing personal loss from being made worse by financial ruin. 

So how do you know much life insurance you actually need? How do you get that number right? 

Tally Up Your Resources

Your resources are your liquid assets and your after-tax income.

The aim of life insurance is to ensure that your family is catered for after a parent departs.

So, take up your monthly income and annualize it, then add up all your liquid assets to get your total assets.  

Determine Your Financial Obligations

Determining how much life insurance you need comes down to what you need today to adequately cover all your current expenses today and in the future. This means that you need to take stock of all your daily expenses. The more thorough you are, the better you are able to predict how much life insurance you actually need.

Financial obligations = Expenses + Debt, and this is what you need to consider when computing your expenses and debt: 

Expenses

Expense factors to consider are numerous based on personal preference and lifestyle. The following the large expense items you need to seriously factor in your cost estimates:

  • Raising a child
  • Caring for ageing parents and their medical expenses
  • Education – from high school to college. 
  • Yearly expenses –  add up monthly expenses and also, include a financial cushion (life insurance can also act as a financial cushion to cater for medical expenses and other discretionary expenses such as vacations) 
  • Funeral – you can also factor in funeral expenses to lessen emotional toll for your family. 
Debt

If you die owing people, your survivors will be responsible for your outstanding debt if they co-signed the loan with you. This means that they will bear the financial burden of all the debt they took with you. When computing how much life insurance you need, consider leaving enough to pay off loans especially if they are secured by collateral that your dependants need to use or inherit i.e. house or car.

Remember, that upon death, creditors may want to seize assets to recoup debt payments. 

Other Considerations

Life insurance is a very individual thing to purchase and therefore, you need to make certain personal considerations before buying any life insurance: 

  • Consider your age  – the older you get, the less life insurance you need in financial terms. This because you will hopefully have less debt to add to your obligations and fewer dependents to support as you have already done the bulk of the work. 
  • Consider your health – the older you get the higher the likelihood of death resulting in higher premiums. Life insurance is cheaper when you are young and healthy, thus you can get a larger coverage amount at an affordable rate.  For these reasons (health and age) it is best to lock-in a good rate as soon as you have insurable needs. 
  • Consider it’s affordability – a higher coverage amount means higher premiums. The exact price of life insurance tends to rely upon a number of individual factors including medical history, lifestyle, age and more. Discuss your needs extensively with your financial advisor and decide the best insurance terms for your needs. 
  • Bonus consideration: After purchasing your life insurance policy and find that your needs have changed later on i.e. have more children or even taken on more debt, you can consider adjusting the coverage with a rider. This is essentially a provision to the policy that could come at an added cost and increase your coverage needs. 

How Much Life Insurance Should You Get? 

How much life insurance you should get is contingent on your coverage gap i.e. the cost your family needs to continue with life after you are gone. 

Here is how you can estimate this amount using an example: 

Resources Amount 
Income ( to annualize compute monthly income after tax x 12)  KES. 4,500,000
Liquid Assets (savings and paper asset investments) KES. 2,000,000
Total Assets KES. 6,500,000
Obligations  
Five-year family support (yearly income x 5 years) KES. 22,500,000
Tuition (assuming you have 3 kids, computed years to complete) KES. 8,500,000 
Funeral Expenses KES. 300,000
Total Expenses KES. 31,300,000
Debt Obligation  
Mortage KES. 5,000,000
Car Loan KES. 2,500,000
Other Loans KES. 150,000
Total Debt KES. 7,650,000
Financial Obligation KES. 38, 950,000*
Coverage Gap KES. 32,450,000**

*Financial Obligation = Expenses + Debt

** Coverage Gap = Financial Obligation – Assets

For the sake of this example, the insurance coverage of this person is coming to KES. 32,450,000 – this is ideally the life insurance coverage this person should buy. However, don’t forget about the personal considerations we mentioned before – age, health and affordability. 

Who Doesn’t Need Life Insurance? 

There are alot of people in this country without life insurance and that is okay. Here are some instances where you might not need life insurance to get by in life:

  • Low-Income earner – most low income earners may find making payment for insurance premiums problematic. Therefore, for those in this category it is better to focus on building a savings nest first for immediate needs. 
  • Single as a kite – no children or any other dependants. 
  • Have group coverage provided by employers. If your employer’s group plan doesn’t work well for your needs, you may want to get an independent policy. 
  • You are self-insured i.e. you have enough financial resources to cover any eventuality i.e. the fabulously wealthy amongst us or the comfortable retirees.  

Overall

A life insurance policy needs to be sufficient and adequate otherwise, it would be either insufficient or wasteful. Using this formula, you can determine with a high degree of confidence how much life insurance is right for you. If you find this is too much hustle, another way to get a rough number of how much exactly you need is to aim for about 10 -12 times your yearly income as your coverage amount. 

Image Credits: Top by Rawpixels via Pexels.

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Irene Makanga
Irene has an MBA in Finance and is an avid businesswoman, passionate about financial literacy.

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