How Do I Determine How Much Life Insurance I Need?

There is no set formula for the amount of Life Insurance cover a person needs. This article will help you decide the amount of insurance you need.

The best way to use this guidance is to look at each element and work out the amount needed, note it on a piece of paper and then add them all up. A simple table at the end of the page is there to help you with working out the amount of Life Insurance cover you need.

Existing Debts

Many families and single people have bought their own home with a mortgage and the average mortgage debt in the UK is about GBP 111,000 (2012 figures). In addition there are the amounts outstanding for bank loans, credit cards etc. (average GBP 8,000 in the UK). So you should work out the total of all your debts.

Funeral costs

The average funeral in the UK will cost anywhere from GBP 4,000 upwards (2012 prices). Funeral costs rise by approximately 5-10% each year, so the effect of inflation should be factored into this area. A quick calculation is that if inflation is at 7.5%, every ten years the figure will double.

Future Education costs for Children

The costs of a person going through university or further education can be substantial. If it is planned to contribute or pay for a child’s further education and leave them debt free, then you need to factor in the future costs into the amount of life insurance you need.

The average UK student starting university in 2012 is expected to have a total debt of about GBP 60,000 when they have completed their course.  With university costs increasing at around 6-7%; inflation should be factored in to the amount needed.

Family maintenance

A young couple with no children with both partners working are less likely to need to make any provision in this area.

However, if one partner does not work or there are children it is necessary to consider how much income the family will need to maintain their lifestyle. If the surviving partner is expected to continue working, then the level of Life Insurance cover will be lower.

A simple equation is the amount of annual income required (at today’s prices) times the number of years it is needed. However this calculation does not take into account inflation or potential investment returns. Therefore further consideration may be needed about the amount of insurance required.

An example:- to provide GBP 20,000 per year for 25 years assuming investment returns of 5% and inflation of 3%, a capital sum of GBP 400,000 would be needed.

Existing Life insurance policies and savings

Once the amount of life insurance needed has been calculated, the amount of existing savings and life insurance held should deducted  to  calculate the right amount of insurance needed.

One or more policies

As one goes through life, the amount of insurance needed changes, so buying more than one policy can make financial sense. For instance; having a policy that just covers mortgages and existing debts means that when everything is repaid, that level of insurance is no longer needed and could be cancelled.

Insurance calculator

Amount needed
Mortgage
Other Debts
Children’s Education
Maintenance
Total

This article is for guidance only and must not be construed as advice. The contents of this article are aimed at the UK market, although many countries will have similar policies available. If you need advice you should refer to a Financial Adviser.

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