There are several methods available to determine how much life insurance coverage to purchase. One method is the family needs analysis. This type of approach estimates the financial needs of the family measured in both present and future terms by evaluating annual expenses and income.

The Procedure:

Step 1: Estimate the total financial needs of the family. How much income is required to maintain the household on a yearly basis? The estimate should take into account the size of the family, the age of the children, the age, health and income of the surviving spouse as well other pertinent personal variables. This dollar amount represents your estimated annual expenses.

Step 2: List all monetary resources that are available to meet the family’s expenses such as cash savings, emergency funds, income from all sources, investments, Social Security benefit payments and other assets. Estimate on the basis of this information your annual income. Optional: note the rate of return (after tax) that the investments earn and the current inflation rate.

Step 3: Compare the annual income and annual expenses. If the expected annual expenses are greater than the expected annual income, the shortfall will have to be covered by life insurance proceeds. A financial planner then can help you determine your exact life insurance needs to cover the annual expenses fully. There are also other variables that will need to be considered in determining life insurance requirements.

Framework For Family Needs Analysis
(the $ amount can be accounted on an individual basis). Not every item will be applicable (e.g., some individuals may not have a debit card or need to have a college savings plan).

Gross Income:

Current After-Tax Income:

Needs Of The Family - Expenses

1. Funeral And Burial Arrangements
2. Uninsured Medical Costs
3. Attorney fees, probate and administrative costs
4. Estate Taxes
5. Childcare
6. Care for a special needs child or other dependent
7. Debt payments:
Credit Card
Debit Card
Mortgage Or Rent
HOA Or Condo Dues
Telephone
Utilities
Other
8. Home Maintenance (e.g., landscaping)
9. Auto:
Loan Payment
Insurance
Maintenance
Other
Allocation for future car purchases
10. Entertainment
11. Household Budget Estimate (Annual):
Clothing/Wardrobe
Groceries
Transportation Or Commuting
Education And School
Out-Of-Pocket Health Care
Other
12. Savings for unexpected financial emergencies
13. Pet Care
14. Miscellaneous

Note: include an extra 15-20% as a safety precaution.

Total Needs Of The Family – Annual Expenses: $

Financial Resources

1. Bank accounts
2. Certificates Of Deposit
3. Current Life Insurance Death Benefit
4. Emergency Funds
5. Income From All Sources
6. Investments
7. Real Estate Holdings
8. Retirement Funds
9. Savings
10. Social Security Payments
11. Other Assets

Special Note: Cash savings and emergency funds should never be used to cover daily living expenses. Do not withdraw funds from retirement plans. Focus on calculating liquid assets that can be quickly converted to cash to generate income.

Total Financial Resources – Annual Income: $

Estimated Life Insurance Needs (See Step 3): $

Additional Factors To Consider In The Needs Analysis:

1. The family’s tax bracket.

2. The need to provide a continuing lifelong stream of income for the surviving spouse.

3. College or higher education funds for children.

4. The family’s lifestyle.

5. The current earnings of the spouse. It is paramount to consider the spouse’s ability to generate future income that is either equivalent to their present salary or higher. Relevant considerations for the surviving spouse include: whether or not the spouse may need or want to work part-time at some point, future job loss or long stretches of unemployment, unexpected illness or disability and the expected retirement age.

6. Funds for long-term care for the surviving spouse.

7. Remarriage for the surviving spouse and how that may impact investments for the children.

8. Whether or not a portion of the insurance proceeds will be utilized to establish trust funds for the children.

9. How the insurance proceeds will be allocated in future investments. It may be assumed that a portion of the insurance proceeds will be invested to earn income needed by the family. Therefore, measuring the impact of future inflation is critical. There are two prime considerations: the withdrawal rate from the funds and the rate of return the capital or investment will earn. It may be necessary to increase insurance coverage as a safety precaution to lessen the impact of investment fluctuations. The insurance proceeds may be invested to provide interest income for the family, leaving the principal more or less intact to pass on to the heirs.

10. Impact of future inflation on the cost of living for the family.

Although this is a fairly basic overview of the family needs approach with regard to life insurance planning, such an analysis can become rather detailed, envisioning a wide range of short-term and long-term needs as well as a variety of future situations. A family needs analysis may actually be more advantageous in determining the amount of life insurance coverage as compared to an arbitrary formula since it generally provides a far more realistic assessment of a family’s accustomed standard of living and actual requirements.

For informational purposes and not intended as advice.