With all your other concerns as an investor in today’s gloomy market, I hate to bring this up, but have you checked your life insurance coverage lately? The amount of life insurance you should be carrying likely depends on the value of your investment portfolio. That makes this a good time to reassess your needs and consider adjustments to your coverage.

First, keep in mind that life insurance is for the benefit of survivors. So it’s the prospective survivors who should determine the appropriate amount of coverage. The question is not “how much do I want my survivors to have if I die?” but “how much would I want to have if I am the survivor?” It’s preferable, for a number of reasons, to have the beneficiary of the life insurance own and control the policy. This isn’t the right approach in every case, but it should be considered.

If someone you’re financially relying on dies unexpectedly early, will there be a financial need that goes unmet by other resources? If so, you need life insurance – enough to satisfy the need. So every couple of years, imagine that you’re in that situation and figure out how much you’d optimally need to carry on.

Life insurance is one of the most widely recognized and best understood of insurance plans. In its simplest form – term life insurance – the arrangement is quite clear. The owner of the policy pays the premium, and if he or she dies while the coverage is in effect, the specified benefit is paid to the policy’s beneficiary. If you stop paying the premium, the coverage ends. Unfortunately, the insurance industry has come up with many ways to complicate the arrangement, mostly for its benefit at your expense, but term life insurance is still alive, well and readily available for those who can qualify.

Most federal employees have term life insurance as an employee benefit through the Federal Employees’ Group Life Insurance program, or FEGLI. The rules governing the coverage are available at www.opm.gov and are fairly complex, but if you haven’t elected extra coverage, you probably have between one and two times your annual basic pay in coverage.

For many employees, particularly younger ones more than a few years from retirement, this is not enough to cover their survivors – generally a spouse and children. For others, it’s too much coverage. Here’s a shortcut to estimate how much you should carry.

  1. Estimate your survivors’ annual needs for spending and saving, in today’s dollars.
  2. Estimate your survivors’ annual income, after taxes, in today’s dollars.
  3. Calculate the difference between the two for each year the benefits will be needed and add up the total.
  4. Subtract from this total the after-tax value of your survivors’ current savings and investment portfolio and the value of any life insurance proceeds or other benefits they would receive.
  5. The difference is the amount of life insurance you should carry for your survivors’ benefit. If your investment portfolio has declined significantly along with the stock market in the past year, your calculation of your survivors’ life insurance benefit needs may have increased by an inverse amount.

Here’s an example of how your calculations might work out:

If you were to die unexpectedly next year, your spouse might need $100,000 per year, after taxes, to meet spending needs and continue saving for retirement in 20 years – so he or she will need about $2 million. In addition, he or she plans to pay for two college educations at $150,000 each and two weddings at $30,000 each. So all together the need is about $2.36 million.

But following your death, your spouse expects to earn about $50,000 per year from employment – a total of about $1 million during the 20 years to retirement. The income shortfall, then, is $1.36 million that needs to be covered by other resources.

You and your spouse already have $200,000 in savings and investments, after subtracting an allowance for the tax burden against your Thrift Savings Plan, 401(k) and IRA accounts, and your current life insurance coverage would pay your spouse $200,000, after taxes. Life insurance benefits are usually tax-free. These resources will provide for about $400,000 of the $1.36 million, leaving a life insurance need of about $960,000.

While this is a simplified example, it should demonstrate a rather quick and reasonably accurate way of determining the amount of life insurance to carry.

Written by Mike Miles
For the Federal Times
Publication February 2, 2009