The formula at a high level:
+ Funeral expenses
+ Total debt
+ Future income needed for beneficiary
+ Total college funding needed
+ Lump sum needed
- Total 'Liquid' Assets
= Your life insurance needs
We calculated all your future expenses and income needs
Within your total college funding need, we looked at the type of college you wanted your dependent to attend as well as the number of children you wanted to send to college and their current age. Their current age helps us determine what college might cost by the time they turn 18.
Then we subtracted your total 'liquid' assets
This is money that your family could access without penalty in the event of your death. In other words, we subtracted traditional savings or stock, but not 401ks or IRAs, which could result in a substantial tax penalty if accessed before your beneficiaries meet the age requirements. And we subtracted any individual life insurance you already own from your total insurance need.
Please note that we didn't calculate employer-based life insurance. While we think having insurance from an employer is great, if you lose that job or leave it, you also lose that insurance. Our belief is that it's best to leave it out of this calculation.
What remains is your total life insurance need
Once you have this figure, you may want to go back and review your inputs to fine-tune your estimate. But by now you should have a good idea of what your dependents will need if you pass on.
The numbers we used
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.
There you have it: our best estimate of what you and your loved ones may need. Of course we can't know everything about your personal situation, so if you've made it this far in the calculations, you might want to speak with a financial advisor. They can verify whether you're taking everything you need to into account. Particularly if you have special circumstances, speaking with a financial advisor may be a good next step. Check out our life insurance needs calculator.
