How much term life insurance should you buy?

Life insurance is designed to value your earnings potential.

You buy insurance to replace a loss, your financial value. What your dependents would lose if they lost you. Life insurance is not used to replace savings. If you have a $100,00 in savings, upon your sudden death, the $100,000 is still intact. The tax man may cometh, but the point is that the asset you had didn't die; you died. What I want to examine is what YOU are worth.

For insurance purposes, your financial value should be based on future earnings, and how long you will be able to work until retirement.

Gross annual income

Assume you earn $40,000 per year. If you die, your loved ones lose $40,000. If you are 40 years of age, and expect to work 25 more years (until you retire) then you would have provided your family with $40,000 x 25 or $1,000,000. That is the most you are worth to your dependents. If you die tommorow, that's what they would lose dollor wise. If you get a $1,000,000 life insurance policy and die soon, they will be provided for.

Death benefit amounts

A smart investor will recognize that $1,000,000 earning 5% interest is $50,000 which is more than the $40,000 you were initially trying to replace. A 40 year old male non-smoker, super preferred rate class can buy $1,000,000 of 10 year term insurance for around $1,500 a year.

Inflation and Life Insurance

If who think $1,000,000 is too much, think about deflation or hyperinflation. Even if inflation is 3%, that will reduce the value of your $1,000,000 by $30,000 a year.

Buy in round face amounts

So if I wanted $30,000 per year for 25 years, based upon 2% inflation and 5% interest, what would be the lump sum amount to get the job done for just 25 years? The more precise number is $541,300. By lowering your insurance from $600,000 to $540,000, you'll be saving yourself a whopping $55 per year. So much for precision. In fact, life insurance is commonly issued in amounts of $100K, $150K, $200K, $250K, etc.

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