Case Study: Is $1,000,000 Enough Life Insurance?
One of the most common questions I’m asked is, “How much life insurance do I/we need?”
My most common answer to that question is, “More than you think.”
Let’s take a look at a real life scenario that I recently worked on where both clients initially thought $1,000,000 of life insurance on each of them was more than enough (names have been changed for privacy purposes):
A Quick Case Study
Arthur and Molly are a married couple with:
· Annual incomes of $80,000 each
· Two children, ages 2 and 4
In the event either of them should pass away, they wanted:
· Their family’s standard of living to remain the same
· The surviving spouse to retire comfortably
Upon the passing of one spouse, the other spouse receives the $1,000,000 benefit. A hypothetical return rate of 5% would create an annual income stream of $50,000. That amount replaces only 62.5% of the spouse’s missing income ($80,000) with no adjustment for inflation.
If Arthur and Molly would like to maintain their current annual pre-tax income of $80,000 (assuming a 3% inflation rate and an annual pre-tax investment rate of 5%), $1,000,000 will last only 14.5 years.
If Arthur and Molly would like to maintain their current annual pre-tax income of $80,000 (assuming a 3% inflation rate and an annual pre-tax investment rate of 5%) for the remainder of their life expectancies (which for them is 50 years), the lump sum needed is $2,600,000.
In the case of Arthur and Molly, they quickly realized that $1,000,000 was not nearly enough life insurance for them.
The key to making sure that you have the proper amount of life insurance is to make sure that you define the following:
1. What do you want to provide if you’re no longer there?
a. For Arthur and Molly, maintaining the family’s standard of living was their key goal.
2. What is your beneficiary’s risk tolerance for investing the lump sum?
a. For Arthur and Molly, they were comfortable with a 3% inflation rate and 5% rate of return. If your views are more aggressive, that will reduce the amount of lump sum needed to provide the necessary income (vice versa if you’re more conservative).
How much life insurance do you think you need? Is it different now than before you read this case study? Let us know in the COMMENTS section below.