When we created our life insurance calculator, we looked at government websites, inflation trends, and national averages, and then used the best information we could find to set rates and reference points for our calculations.
The magic formula:
To determine how much life insurance you need, we ask you some quick questions, and then use this formula:
+ Funeral expenses
+ Total debt
+ Future income needed for beneficiary/ies
+ Total college funding needed
+ Lump sum needed
- Total 'liquid' assets
= Your life insurance needs
We calculate all your future expenses and income needs
Your future expenses and income needs are the total of funeral expenses, debt repayment, income needed by your beneficiaries to support them, and estimated future college expenses based on your child’s age and what type of college they may attend.
We subtract your total 'liquid' assets
Liquid assets is money that your family can easily access without penalties, like regular savings or stocks. However, we leave out 401ks or IRAs because withdrawing from these accounts too early can result in hefty tax penalties. We also subtract any individual life insurance you already have from your total insurance need.
Please note: we don't factor in life insurance from your job. While it's nice to have, if you change jobs or lose your job, you lose that insurance too. We think it's best to keep it separate from this calculation.
What's left is your total life insurance need
Once you've gone through these steps, you'll have a ballpark figure of what your loved ones might need if something happens to you.
Behind the numbers
If you're interested in the actual numbers used in our calculation. Here's the background:
- Funeral expenses — We used $10,000 as our estimate for final expenses. According to the National Funeral Directors Association, the median cost of a funeral in 2012 (the latest year of the study) was $8,343; however this doesn't include the cost of a cemetery plot or monument, which can cost an additional $1,000-$2000. You should also be aware that like general cost of living expenses, funeral expenses vary greatly by state and city.
- Inflation rates — Inflation rates are used to project the amount of money you will need in the future to maintain the buying power of your current income. We used a 2% annual rate of inflation to calculate our numbers. According to the usinflationcalculator.com, the average annual inflation rate for the last 10 years (2005-2015) was 2.14%, and it has trended down over the last several years.
- Investment return rate — This rate varies greatly based on your risk tolerance and market performance. For our calculations, we assumed your current investments grow at a solid 5% annual growth rate.
- College expenses — According to collegeboard.org, the estimated average cost for college in 2014-2015, including tuition, room and board were:
Type of school
$18,943
public in-state
$11,052
Two-year, public in-district
$32.762
Public out of state
$42,419
Private non-profit
As for how to project that out into the future, many sources indicate that while costs have risen dramatically in the past, they likely cannot continue at the same pace moving forward. Most advisors will tell you to plan for college costs to escalate at twice the annual rate of inflation. With that in mind, we projected college expenses to grow at a 4% annual rate.
These numbers give you a starting point, but remember, everyone's situation is unique.
Want to know how much term life insurance you may need? Answer a few simple questions to calculate your potential needs here, and you’ll have checked off the first step toward securing your financial future!