CFP

LIFE INSURANCE
The role life insurance plays in providing death benefits is apparent. A family's desire to provide protection against the loss of its breadwinner is certainly implicit to provide life insurance. Or maybe a small business that needs to protect itself against the death of a key employee is often protected by a life insurance policy. One question that is often misunderstood is, "how much insurance is enough? There are two basic approaches used today in determining the proper coverage amount. The older method known as the human life value approach has been largely replaced by the more sensible needs approach. Either will help answer the basic question "how much is enough".

Human Life Value Approach
The human life approach projects the income of the individual though the remaining life expectancy. Then, using a discount rate, the present value of the life is calculated. A relatively simple calculation:

• Calculate the taxpayer's average annual earnings after taking out taxes and living expenses.
• Estimate the number of years the taxpayers is expected to work before retirement.
• Select a logical interest rate at which future earnings should be discounted; and
• Multiply the present value of one dollar payable annually for the number of years until expected retirement, using the selected interest rate, by the estimated average future annual earnings.

Example: Ralph is 35 and expects to earn an average of $40,000 a year until retirement until age 65. Of the $40,000, $25,000 is devoted to the care and maintenance of his family, the remaining $15,000 goes for taxes and living expenses.

Based on the basic assumptions, we can see that Ralph's family will need and use $750,000 ($25,000*30 years).

Calculating human life approach is one method of determining "how much". This approach has come under criticism by experts who point out that it does not take into account inflation or the likelihood of increases in wages or living expenses.