Life insurance - how much?

My post summarising in very simple terms the three main types of life insurance concluded that term life is useful if you have dependants but that whole of life and investment linked policies are wealth destroyers and should be avoided like the plague.

James pointed out that I had not addressed the important question of how much life insurance is needed.

So how much insurance is needed?

There is no universally correct number however the following may serve as a starting point:

If you have no dependants

If you have no dependants (or people you wish to benefit in the event of your death to an extent that exceeds the net assets of your estate): zero - you do not need any life insurance.

If you have a spouse/significant other but no children

If either (i) your spouse is financially independent through employment or other means or (ii) your estate (net of debt) will provide sufficient wealth to meet his/her financial needs, the theoretical answer is that you do not need life insurance. That said, a discussion with your spouse on the subject would be in order - you may conclude that a policy sufficiently large to pay off the home mortgage and any other debts is appropriate - especially if those debts could not otherwise be met out of the estate.

If your spouse is wholly or partly financially dependant on you, then things get a bit more complicated. The correct amount of life insurance is an amount which when aggregated with the net value of your estate (i.e. after paying off the mortgage and other debts) will be sufficient to sustain your surviving partner in the same life style as at present (or something acceptably close to it) for life. The ability and willingness of a non-working spouse to (re)enter the workforce, age and other factors will all affect the number that comes out of this exercise.

If you have children

If you have children, the bottom line is that you should provide through a combination of inheritance and life insurance, sufficient funding for them to become functional independent adults. Notwithstanding my father's opinion that this does not happen until the children reach at least 40, I would normally settle for ensuring that their cost of living, education costs etc are covered until they have completed an undergraduate degree. Anything beyond that is nice to have but not a necessity.

Once the children are grown and financially independent, life insurance to benefit them becomes optional.

Adding it up

The aggregate needs of a surviving spouse and children (net of estate assets) is the minimum amount of term life coverage I would consider necessary. Anything less may involve subjecting your surviving family members to undesirable financial constraints. Anything more, and you need to weigh the cost of the premium against the additional payments to your family.

What if the insurance premium is too great an expense?

Then you will need to accept that you cannot provide for both your spouse and your children in full and will need to make some compomises. If you have to make compromises, I would prioritise as follows:

first: discharge of any mortgage or other debts which cannot be met out of the estate

second: educational expenses for children (to be held on trust)

third: enough money to support your spouse for a year or two while he/she adjusts and/or finds a job

Annual review

An annual review is in order. As the children grow older, your spouse grows older and you accumulate assets, the amount of life insurance needed will usually decline (absent other factors). You may eventually reach the stage where it is no longer necessary and you can save yourself the expense of further premium payments.

My own situation

Until recently, our life insurance needs were relatively modest. My spouse was working and able to support herself and our children if the mortgage had been paid off. So I took out a term life policy which (i) would discharge the home mortgage and (ii) would leave small legacies to my siblings (based on love and affection rather than financial need). Under my estate my wife would take our current home and the previous home while the remainder of my estate would be held on trust for our children. Given my wife's earnings and the value of the estate, it was not necessary to provide life cover for our children.

That position has now changed. Mrs traineeinvestor has resigned from her job so that one parent can stay at home to deal with school work etc (she is still negotiating a finish date). Also, I drew down against the home mortgage to fund an investment in my employer which means that the life policy would not cover the home mortgage any more. Accordingly, I need to increase the amount of cover. My wife and I are working through the numbers but the likely outcome is that I will need to double the size of the cover when the policy comes up for renewal.