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The wise King Solomon once gave us the following proverb: “A good man leaves an inheritance to his children’s children.”

One amazing thing about the modern world is that, regardless of whether you have little or much, almost anyone has the option to leave a significant inheritance through the option of life insurance. And while inheritance is not usually a front-and-center topic during our young and vibrant years, building a comprehensive wealth structure would not be complete without a contingency plan to care for our loved ones after we’re gone from this earth.

Counter to popular opinion, the case is often that the subject of inheritance is most important when one is young and in the accumulation phase of life. When there are kids to provide for, or a spouse to ensure continued support for many years to come, life insurance becomes of utmost importance. Not only does it allow for peace of mind, but it’s a simple way to provide a hugely outsized reward for the relatively small out-of-pocket cost.

If you’re interested in the Excel spreadsheet I use for calculating life insurance needs, you’re welcome to access it here.

Let’s dive into the factors to be considered when determining the right amount for you. Obviously, we hope life insurance never has to be used; neither we nor the insurance company expects it to ever be needed. But in the unlikely case that it is, it can make a world of difference to those who survive us.

How Much is the Right Amount for Me?

There are many types of life insurance and various reasons to purchase it. These reasons may include the payment of income taxes or estate taxes after death, the gifting of funds to a charity, college funding for children or grandchildren, or most commonly the continued support of dependents or a spouse.

To narrow down our options for the purposes of calculation here, let us assume that the basic reason for purchasing insurance is to ensure the continued support of your household members. This is usually accomplished through the cheapest and most popular type: term life insurance.

Here are a few starting questions to ask yourself:

• Is my spouse/partner/etc. able and willing to work and support him or herself after I’m gone? If so, what is the likely earning potential?
• Do I have kids, and what are their ages? Do I intend to fund their future education, house purchase, wedding, etc.?
• What are the estimated future living expenses? Separate these into basic needs (shelter, food, clothing, utilities, etc.) and discretionary spending (entertainment, travel, holidays, etc.).
• What is the estimated time horizon for the length of support needed? This would typically be the years until the kids are likely to be independent, as well as the life expectancy of the spouse.
• What age does my spouse intend to retire? Will he or she need additional cash flow from that time onward?
• How much is already saved away, whether in a retirement account or a taxable account?
• What is the risk tolerance of my beneficiaries when it comes to being invested in the stock and bond markets? Will they be able to stomach watching the ups and downs of equity markets, or will they be tempted to move to something less volatile? This will determine what number we use when estimating future return on investment.
• What is the estimated inflation over the course of the time horizon?

Of course, there are many assumptions that go into knowing the right amount of insurance to purchase; however, with an educated guess, we can have a strong likelihood of securing an amount which meets the needs of the beneficiaries for years to come.

Let’s Take An Example Calculation

Jack and Tonya, both age 30, are married with two children. Here are the relevant facts:

• Jack works full-time making $60,000 per year while Tonya works part-time earning $30,000. Tonya could make $60,000 if she needed to work full-time.
• The two kids are ages 2 and 5.
• Tonya has said she would not want to give up the discretionary spending if she were widowed with two children. We will assume expenses remain about the same.
• She is comfortable with some volatility of markets, but doesn’t want to regularly see the kind of volatility typically associated with an all-stock portfolio.
• Their retirement and other savings are minimal. We will assume these are zero.
• She estimates, based on life expectancy tables for a healthy female in the US, that she should plan to live until about age 83.
• They would also like to fund $75,000 apiece for their kids’ future college education and $10,000 apiece for wedding expenses.

• They do not plan to assist with a future house purchase for the kids.

Jack, being the higher earner because of hours worked, wants to ensure that his family is cared for if some disaster were to befall him. He and Tonya have spoken about this, and she has indicated she would be willing to go to work full-time if needed in a circumstance of Jack’s passing, likely able to make $60,000 if she did so. This would leave her $30,000 short of what is currently being earned between the two of them. 

With these details in mind, let us calculate a reasonable amount of life insurance to purchase for Jack.

Assuming Tonya plans to invest life insurance proceeds in a mix of stocks and bonds (let’s say 70% stocks and 30% bonds), we might estimate a reasonable long-term average return to be something like 6%. 

While the US Federal Reserve’s target average inflation rate is 2%, let us assume that they miss that target over the next 50 years and instead see an average inflation rate of 2.5%.

The following computation can be done in a spreadsheet like Microsoft Excel. I am presently putting together a spreadsheet template that will include this calculation which I can share for ease of use.

Looking at a year-by-year estimate of outgoing expenses versus investment value, we can see that $710,000 would get us (by these assumptions) to age 83 with a small cushion left over.

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In addition to this, however, they also want to provide for $75,000 per child when they go off to college and $10,000 per child’s wedding fund. This additional $170,000 can be added onto the $710,000 for a total of $880,000 in needed life insurance.

Some additional considerations might be made if Tonya intends to increase her withdrawal amounts after retirement. For example, if she plans to need $45,000 after retirement at age 65, then an additional calculation would need to be performed with this in mind.

Conclusion

For a customized recommendation on the specific amount of life insurance appropriate to your situation, a life insurance agent would be able to gather the above information specific to you and to calculate the amount that would meet your needs and goals. 

Remember, the easy thing to do is put this off until later years, or to rely on your workplace life insurance plan (until you leave the company). But the early bird gets the worm, as they say. If you lock in a rate for 30 years on a term policy when you’re just starting out in your career and family life, you’re far more likely to secure a better rate that lasts throughout the majority, if not the entirety, of your working career.

The goal is that, once you come to retirement, you are able to build enough savings that life insurance is not absolutely necessary at that point. For a small upfront effort, the rewards for making these preparations can make an enormous difference for the survivors of an untimely passing.

Simply knowing that you have an inheritance lined up for your loved ones, just in case, offers immense peace of mind as you continue your journey toward comprehensive wealth.