Even when you have decided to buy insurance, the problem still arises as to whether you have the right amount of insurance. Most people are either underinsured or over insured. The problem for those that are underinsured is that when it is time to make a claim, it is never enough to get them back to their previous position. For the over-insured, the problem is that they are paying premiums that are too high.
A popular approach to buying insurance is based on income replacement. In this approach, a formula of between five and ten times your annual salary is often used to calculate how much coverage you need. Another approach is to purchase insurance based on your individual needs and preferences. The first step is to determine your unique income replacement needs.
Currently, a large portion of your income goes to taxes (insurance benefits are generally income tax free) and to support your own lifestyle. Start off by determining your net earnings after taxes. Then add up all your personal expenses such as food, clothing, magazine subscriptions, club memberships, transportation expenses, etc. The remainder represents annual income that your insurance will need to replace.
You’ll want a death benefit amount which, when invested, will provide income annually to cover this amount. Then, you should add to that the amounts needed to fund one-time expenses such as college tuition for your children or paying down mortgage or debt.
Income replacement for nonworking spouses is an important and often overlooked insurance need. Coverage should provide for your costs for day care, housekeeping, or nursing care. Add to this any net earnings from part-time employment. Finally, estimate your own “final expenses” such as estate taxes, uninsured medical costs, and funeral costs.
It will be hard to get an insurance agent who is going to inform you if you are not adequately insured. To them a tiny sale is better than no sale at all. So it is only wise to make sure you understand what you are getting in your insurance package and understand the ramifications to your pocketbook.