Affordable Life Insurance

Affordable Life Insurance Policies From $26/mo

Protect your family with an affordable life insurance policy. The multiples-of-salary approach is used to determine the amount of life insurance required as income replacement. The reasoning behind this method is that, if the breadwinner dies, the family will need 75 percent of his or her after-tax income. This approach was developed by First National City Bank (Citibank) of New York City, which recommends that insurance provide at least 60 percent and preferably 75 percent of after-tax income replacement.

When this approach was first developed in 1976, it was assumed that the life insurance proceeds would produce a before-tax yield of 5 percent above the inflation rate (e.g., for an inflation rate of 4 percent, the pretax yield should be 9 percent; this may well be too aggressive an assumption). Another assumption is that principal will be exhausted during the surviving spouse’s life expectancy.

How Much Life Insurance Do You REALLY Need?

According to the multiples-of-salary if your spouse is 45 and your gross earnings total $65,000, the amount of life insurance you need to replace 75 percent of your after-tax income is $487,500 ($65,000 times 7.5). For a 60 percent replacement, $390,000 is needed ($65,000 times 6.0).

The multiples-of-salary factors were developed with the assumption that the family will be receiving social security benefits. In addition, other assets in excess of 1 year’s income (e.g., savings, retirement plans, or potential inherited money), to the extent that they are in excess of 1 year’s gross earnings, can be used to reduce the amount of cheap life insurance needed. In the example cited above, if your other assets add up to $130,000, you may reduce the $487,500 by $65,000.

The X times earnings and the multiples-of-salary methods for determining how much life insurance is enough to replace income can be calculated without using a computer or a financial decisions calculator, provided that the life insurance agent has the necessary experience, economic background, and analytical powers to custom-design these approaches to suit your specific situation. These characteristics are necessary because these two methods fall into the classification of rules of thumb.

Use of the insurance needs analysis to determine the amount of affordable life insurance needed for income replacement requires a computer and the necessary financial decisions software. Before the day of the computer, this approach was referred to as the programming approach, as it still is by some today. Those using the approach today, however, commonly refer to it as “insurance needs analysis.”

The analysis is done by first measuring current needs (e.g., funeral costs, federal estate taxes, state inheritance taxes, settlement of non-mortgage debt, settlement of mortgage debt if desired, an emergency fund, a college fund, and expected living expenses). Survivors’ income needs can be divided into time periods. For instance, a surviving spouse may need a certain amount of income until the children leave home, and then the needed amount may drop to some lower number.

Once all the needs are measured, the calculation is made, using an inflation factor, and then all monies are discounted back to current time (today).The amount of money needed today is the amount of life insurance required. The amount calculated is reduced, however, by any existing life insurance or other assets already in place. The net figure is the amount of affordable life insurance that the individual should buy. The calculation assumes that principal will be exhausted. The calculation uses as a point in time the life expectancy of the surviving spouse.