Our goal is to maintain our family's standard of living in the event of our premature death. How much life insurance do we need to accomplish this?
Understanding the calculator ↓
Suggested coverage
$1,005,781
Provides $60,000/year for 20 years, indexed at 3% inflation.
Year-by-year breakdown
| Year | Start balance | Replacement income | Interest | End balance |
|---|---|---|---|---|
| 1 | $1,005,781 | $60,000 | $47,289 | $993,070 |
| 2 | $993,070 | $61,800 | $46,564 | $977,834 |
| 3 | $977,834 | $63,654 | $45,709 | $959,889 |
| 4 | $959,889 | $65,564 | $44,716 | $939,042 |
| 5 | $939,042 | $67,531 | $43,576 | $915,087 |
| 6 | $915,087 | $69,556 | $42,277 | $887,807 |
| 7 | $887,807 | $71,643 | $40,808 | $856,972 |
| 8 | $856,972 | $73,792 | $39,159 | $822,338 |
| 9 | $822,338 | $76,006 | $37,317 | $783,649 |
| 10 | $783,649 | $78,286 | $35,268 | $740,630 |
| 11 | $740,630 | $80,635 | $33,000 | $692,995 |
| 12 | $692,995 | $83,054 | $30,497 | $640,438 |
| 13 | $640,438 | $85,546 | $27,745 | $582,637 |
| 14 | $582,637 | $88,112 | $24,726 | $519,251 |
| 15 | $519,251 | $90,755 | $21,425 | $449,921 |
| 16 | $449,921 | $93,478 | $17,822 | $374,265 |
| 17 | $374,265 | $96,282 | $13,899 | $291,882 |
| 18 | $291,882 | $99,171 | $9,636 | $202,346 |
| 19 | $202,346 | $102,146 | $5,010 | $105,210 |
| 20 | $105,210 | $105,210 | $0 | $0 |
Understanding the calculator
Basic principles of insurance tell us that to determine the amount of coverage, we simply match it to how much money was 'lost'. If we have a car accident and total our car, the amount we lost was the value of the car. The car was worth $50,000, it's gone, the insurance company gives us $50,000 and we buy the same car. Not too much, not too little. That's the goal.
With life insurance, the financial loss is a bit more opaque. So we start with our goal, a statement of "in the event of our premature death, we want to maintain our family's standard of living". How do we translate that into a financial number?
Well, for most of us, our standard of living is dictated by our income. We work, earn an income, and the spending of our income on groceries, bills, mortgages or rent, car payments, etc, is our actual standard of living. And if we pass away prematurely, we've lost our income — there's the financial loss.
Therefore, if we are looking to maintain our family's standard of living, we need to replace our income.
And by contrast, we do not insure debt like mortgages or assets like our savings. We only insure the actual financial loss which for most of us is our income.
Of course there's a few variables. First we probably want to assume that we don't need 100% of our income. Perhaps we only need a lesser percent that will still allow our family to maintain their lifestyle. Common percentages are 60–80%, but use what you feel comfortable with. We also assume we are replacing the income over a number of years. Commonly people will look at years until retirement, or long enough to get the kids financially independent. (Note, when you determine the replacement timeframe, you're also determining how long you likely want coverage for — which you are going to use in step 3, so remember that.) Then we assume a conservative interest and inflation rate. With those numbers, the calculator will tell you how much life insurance you need in order to meet those goals.
For example, 60% of $100,000 over 20 years produces an insurance need of $1,005,781. And what that means is that if you take $1,005,781 today and put it in the bank, your family can draw down 60% of your income for 20 years — and at the end of 20 years the insurance proceeds have gone to zero.
We recommend trying different percentages and number of years so that you develop a sense of the range of coverages that you should be considering.