Determining how much life insurance you need requires careful thought about your family's financial situation. The goal is to ensure your dependents can maintain their lifestyle if you die, without paying for more cover than necessary. Several approaches can help you arrive at an appropriate figure.
There is no single right answer. Your needs depend on your specific circumstances.
ACC Context for Life Insurance
In New Zealand, ACC covers accidental death at 80% of income for dependents. This means life insurance is primarily protecting against death from illness (cancer, heart disease, stroke) rather than accidents. When calculating your needs, consider that ACC provides some protection if you die in an accident, but nothing if you die from illness. Most deaths during working years are from illness, making life insurance essential despite ACC coverage.
The Income Replacement Method
A simple approach is multiplying your annual income by the number of years your family would need support. If you earn $80,000 and want to provide 15 years of income, that suggests $1.2 million cover.
This method is straightforward but imprecise. It does not account for your family's actual expenses, existing assets, or changing needs over time.
It provides a starting point for conversations about appropriate cover levels.
The Needs Analysis Method
A more thorough approach calculates specific needs your family would face. Start with immediate expenses: funeral costs, any debts you want paid off, and an emergency fund.
Add ongoing expenses: housing costs, food, utilities, transport, education, and other regular expenses for your family. Estimate how many years these expenses continue.
Subtract existing resources: life insurance through work, savings, investments, and any other assets your family could access. The gap is what you need to cover.
Debt Considerations
Many families want their mortgage fully repaid if a parent dies. Calculate your current mortgage balance and add it to your life insurance needs.
Consider other debts too: car loans, student loans, and credit cards. Do you want these eliminated, or can your family manage them from ongoing income?
Debt repayment is often the largest single component of life insurance calculations for mortgage-holding families.
Education Funding
If you have children, consider their education costs. This includes school fees if attending private schools, university costs, and living expenses during tertiary education.
Education costs add significantly to cover needs for families with young children. A 5-year-old has 15 or more years of education ahead.
You may choose to partially fund education, provide for university only, or fully fund all education. Your choice affects your cover amount.
Income Versus Expenses
Your income is not the same as your family's expenses. If you die, some expenses reduce: your food, transport, and personal spending.
However, some expenses may increase. Your family might need to pay for services you provided, like childcare or home maintenance.
Working from actual expenses rather than income provides a more accurate picture of what your family needs.
Existing Cover And Assets
Factor in cover you already have. Many employers provide basic life insurance as a workplace benefit. This reduces how much personal cover you need.
Consider your savings and investments. Could your family live on returns from investments rather than needing full income replacement?
Do not forget your partner's earning capacity. If your partner works or could work, their income contributes to family support.
Decreasing Needs Over Time
Life insurance needs typically decrease over time. Your mortgage reduces as you pay it down. Your children grow up and become independent. Your retirement savings increase.
Some people reduce their cover as circumstances change. Others prefer to maintain cover for the certainty it provides.
Regular reviews ensure your cover matches your current needs rather than circumstances from years ago.
Getting Help
These calculations can become complex. A financial adviser can help you work through the numbers and identify an appropriate cover level.
Advisers often have tools and frameworks for needs analysis. They can also help you understand how different cover amounts affect premiums.
The goal is cover that protects your family adequately without over-insuring.
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