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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?
The key is to see that insurance is intended to replace financial loss in the event of our death. What's the financial loss? Well, our family's standard of living is dependent on our income or paycheque - we earn a living, bring that money home and spend it, and that spending generates our family's standard of living. In the event of our death, financially we lose that income. Therefore we focus on the loss of our income (and in particular, loss of our income over years) to determine how much life insurance we should consider.
By contrast, we don't need to insure things like debts, mortgages, or additional desires. None of these things are losses, which means they aren't properly insurable. Further, debts and mortgages are paid for through our income - so if we use life insurance to generate a new paycheque in the event of death, our beneficiaries use this replacement to continue to pay the mortgage, service debt, etc - in short, continue to maintain their current standard of living.
Your Annual Income: This is your gross (before tax) annual income; how much you make.
Percent of Income Needed: What percent of your income does your family need in order to maintain their current lifestyle? Probably less than 100% as there's one less person. Common answers are in the range of 60-80%. Try different values in order to develop a sense of what's reasonable for you.
Interest Rate/Inflation Rate: These numbers are used to take a lump sum death benefit and translate it into an 'annual replacement paycheque'. We suggest that you use conservative numbers, otherwise it requires that your family achieve aggressive interest rates after you pass - probably counter to what we actually want.
Number of Years to Replace Income: If you pass away tomorrow, how long do you want to maintain your family's standard of living for? Common answers are 1) Until your youngest child is completely financially independent and 2) Number of years until retirement. Again, try different values in order to get a sense of what's reasonable for you.
View Full Results: Clicking this link will expand into a table to show you how the calculated life insurance amount is used to exactly generate a 'replacement' income upon your death, for the number of years you selected. After that time there's no more life insurance money left - nobody got rich, but we maintained our family's lifestyle for the time we wanted.