How much insurance a person needs would vary, depending on lifestyle, financial needs and sources of income, debts, and the number of dependents? When considering life insurance, you’re planning and preparing for an event most of us would rather not think about. But life insurance represents a critical step in managing your personal finances and ensuring your family’s well-being.

Buying life insurance doesn’t have to be a complicated matter. Simply determine how much cover you would be likely to need before searching online for the best deal. Factors you should consider when deciding how much life insurance you need to take include how much is left on your mortgage; how much money your partner and the household would lose through loss of your earnings; how much it would take to bring up the children in your family; and how much would such things as childcare cost if your partner had to return to work.

Once this has been determined then it’s simply a matter of finding the right cover. It is important that you choose the right type and amount of cover for your policy and a specialist broker will be able to help. An insurance adviser or agent would recommend that you take insurance that amounts to five to ten times your annual income.

The two approaches to life insurance

You can use one of two approaches to estimate how much life insurance you should buy: the needs approach or the replacement-income approach. Using the needs approach, you calculate the amount of life insurance necessary to cover your family’s financial needs if you die. Using the replacement-income approach, you calculate the amount of life insurance you need to equal the income your family will lose. Let’s look briefly at each approach.

You need how much?

Using the needs approach, you add up the amounts that represent all the needs your family will have after your death, including funeral and burial costs, uninsured medical expenses, and estate taxes. However, your family depends on you to pay for other needs, such as your child’s college tuition, business or personal debts, and food and housing expenses over time.

The needs approach is somewhat limiting. The task of identifying and tallying family needs is difficult, and separating the true needs of your family from what you want for them is often impossible.

Replacing Income

Using the replacement-income approach for estimating life insurance requirements, you calculate the life insurance proceeds that would replace your earnings over a specified number of years after your death.

Life insurance companies sometimes approximate your replacement income at four or five times your annual income. A more precise estimation considers the actual amount your family members need annually, the number of years for which they will need this amount, and the interest rate your family will earn on the life insurance proceeds, as well as inflation over the years during which your family draws on the life insurance proceeds.

Note: Do remember as you quantify the income you want to replace that Social Security provides generous survivors benefits if you’ve qualified. These benefits can easily total $2,000 a month or more.

Calculating Replacement-Income Amounts with Excel

If you’ve got access to a computer running Microsoft Excel, the popular spreadsheet program, you can use your computer to calculate the amount of insurance you need to replace a specified number of years of income. Suppose, for example, that you want to buy enough life insurance to replace the income from a $50,000-a-year job for 15 years. If you figure your family will earn 5% on the life insurance proceeds should the worst-case scenario occur, you enter the following formula into a cell in an Excel workbook to calculate the replacement income life insurance amount:

=-PV (5%,15,50000)

Excel returns the formula result 518,982.90 indicating that you would need roughly $520,000 of life insurance, invested at 5%, to payout $50,000 a year for 15 years.

Two Calculation Tips

If you want to factor in inflation because you’re trying to replace income over a long period of time, you should use a real rate of return rather a regular, or nominal, rate of return.

To calculate a real rate of return, subtract the inflation rate from the interest rate in the formula. For example, if you expect 2% inflation, you could replace the formula shown earlier with this formula:


Here’s a final calculation tip: You probably want to round up your number. For example, if the formula provided earlier returns the value 518982.90, you might want to round up this value to $600,000. Or $750,000.

  Advise. Insure. Prosper

Our professional team at Advisen Life & Wealth have a very strong commitment to providing specialized, personalized, and quality insurance plans to all our clients at extremely competitive pricing, and in an accurate and efficient manner.