There’s no arguing that life is priceless. But when figuring out how much life insurance you need, it’s essential to determine how much you’re worth to your family. Otherwise, you’ll probably have too much or too little insurance coverage.
Many consumers use the “multiple of earnings” method to figure out how much life insurance coverage they need. With this method, you look at your annual salary and decide how many years your family would need to be covered if you died. So if you earn $75,000 and want your family to be covered for five years, you would need $375,000 in life insurance coverage.
However, many experts believe this technique is not very effective. It doesn’t consider wage increases, and it can be challenging to determine how many years your family will need to be covered. Plus, this technique doesn’t measure your non-wage value. Non-wage contributions include essential duties such as cleaning the house or taking care of your children-tasks your family might have to pay someone to do if you were no longer living.
Many financial experts believe that Human Life Value calculations are more effective in gauging the appropriate amount of life insurance coverage one needs. Courts often use this method to determine the amounts to be awarded in wrongful death lawsuits. Although this technique is much more complicated than the multiple of earnings method, it can offer a more precise estimate of your value.
The first step in calculating your Human Life Value is to add the current value of all future income you expect to earn plus any other value you plan to contribute to your family until your projected retirement date. You then subtract your taxes and personal expenses from now through your retirement date. Next, you adjust this yearly amount for inflation over the years until your planned retirement. Finally, you apply a “discount rate” to each year’s projected total value- this accounts for what’s called the “time value” of money.
For example, a 30-year-old man named Tom plans to retire at age 60. His annual salary is $45,000, and 20% of that goes into his living expenses, while the remaining 80% of his income goes to his family. Tom provides additional value for his family by doing the yard work, handling all the house and car repairs, and making a few other non-wage contributions. When added, he contributes about $14,000 of non-wage value to his family each year. (This is the estimated cost of a skilled worker to perform these same tasks.)
Therefore, Tom’s total annual value to his family comes to $50,000: 80% of his $45,000 salary ($36,000) + Non-wage value ($14,000) = $50,000.
Next, Tom needs to adjust his value for annual inflation. At a 3% yearly growth rate, his value will increase to $121,363 by the time he reaches his projected retirement age of 60.
Finally, Tom applies the discount rate to each year’s projected value to represent the time value of his money. At a discount rate of 4%, Tom’s projected value through age 60 is a little more than $1 million. Based on these calculations, Tom needs $1 million of life insurance coverage to protect his family if he adequately dies.
Calculating your Human Life Value can be a complex process. You may want to meet with Brian Gruss to determine how much life insurance coverage you need, and Brian Gruss can help you calculate your value and ensure your family is adequately protected.