I am sometimes asked, “How much life insurance should a person like me have?” Of course there is no way for me to answer that question without knowing the persons objectives, that is, knowing what the person would like the life insurance to accomplish.
Let’s compare two families that are remarkably similar; same age, same number of children, similar incomes and debts. Even in this scenario, their need for insurance could be vastly different if their objectives were dissimilar.
For example, one family may put the utmost importance on education, so that not only would private college be funded in the event of the breadwinner’s demise, but grad school also. The other family may feel that community college and state school is sufficient. In that case, the insurance need for each family would be substantially different.
Once one’s objectives are determined, calculating an appropriate amount can be reduced to a simple mathematical computation. Of course certain items may need to be estimated, such as interest rates and life expectancy.
But objectives always drive the amount. Sometimes a person will scale back the amount after they see how much is required, but that is a budgetary matter and not objective driven.
Determining one’s objectives is usually a stumbling block, as that entails confronting one’s own mortality which as discussed ad nausem is one of the primary reasons for not acquiring life insurance.
So the amount needed is determined by one’s objectives, but the amount (and type) acquired is determined by one’s budget. Ideally the budget is sufficient to acquire the amount needed, but sometimes it isn’t.
If at all possible, the amount needed should not be reduced. Reconfiguration of the type of insurance to be acquired is preferable to reducing the amount. For example, very often 20 year term insurance is utilized not because the need is temporary, but rather because the budget demands it.
However, sometimes even the premium for 20 year term comes in over budget. In that case, reducing the length to 10 years is preferable to reducing the face and keeping the length 20 years. Reducing the face amount should always be a last resort.
So the first step in acquiring life insurance is to determine objectives. Objectives will obviously be very different for a young person starting out than for a middle-aged recently re-married person. But if the time isn’t taken to determine one’s objectives, then any amount acquired is just a guess. Better than procrastinating, but certainly not the preferred method.