New York -- How much life insurance do you need? This question has as many answers as the number of people trying to sell you a policy.
Many life insurance agents and financial planners use computerized formulas that supposedly take your individual circumstances into account. The results look beautifully exact. But these formulas actually produce widely different proposals for the same family, depending on the assumptions each company makes.
I once ran a test of four of these programs, using a hypothetical family. Their recommendations for the amount of additional insurance needed ranged from zero to $421,000. In short, if you used these formulas and happened to get the right amount of coverage, it probably was an accident.
If you are mathematically inclined, you can figure out exactly what you need by doing some projections yourself (or with the help of an accountant). You decide how much annual income your family would need if you died, and the number of years they would need it. Then compare that amount with the income and assets they'd have available if you died now. If it's not enough, you'd buy extra life insurance to plug the gap.
For insurance buyers who won't bother with exact calculations (the majority, I'd guess), James Hunt, a director of the National Insurance Consumer Organization (NICO), has a rule of thumb. A four-person family with one wage earner and two young children should buy five times the wage earner's annual income. If you're making $40,000 a year, for example, you need $200,000 worth of coverage.
This assumes that the wage earner also has coverage through his company equal to two or three year's salary, Hunt says. If not, you should buy a policy equal to seven to eight times income.
The rule also assumes that the family would be eligible for Social Security survivor's benefits.
To find out, call (800) 772-1213, ask for the Personal Earnings and Benefit Estimate Statement, fill it in and mail it to Social Security.
Even with Social Security benefits, Hunt says, coverage equal to five times earnings represents a compromise between what the average family needs and what it probably can afford. If you have enough money, Hunt says, it makes good sense to add another $50,000 in coverage -- especially if you doubt that the non-working spouse could get a well-paying job.
If both spouses work, buy a minimum of five times the income of the higher wage earner, split proportionately. For example, assume that one spouse makes $40,000 and the other makes $25,000, which is around 40 percent less. You'd buy at least $200,000 worth of coverage, putting $125,000 on the higher earner and $75,000 on the lower earner. The cheapest way to cover the lower earner, NICO says, may be to add a spouse rider to the higher earner's policy.
The cheapest way for anyone to get coverage is to buy low-cost term insurance. A 30-year-old man who doesn't smoke and is in fine health should be able to find $200,000 worth of annually renewable term coverage for $212 a year or less, NICO says. That same man at 40 should be able to pay $266 or less and at 50, $520 or less. Smokers pay more, as do people who slip out of the top health classification.
Your family can probably get by on less than five times income if you have fewer than two children or if your children are almost grown. Ditto if you have a large amount of savings or investments.
By contrast, you may need more coverage if your family has more than four members or if you don't want an at-home spouse ever to have to look for work.
If you're single with no dependents, you don't need life insurance. Your money is better spent on disability insurance (which pays you an income if you can't work), a good health plan, and savings and investments. Policies shouldn't be bought on children.
For Hunt's excellent guide on how to buy the most appropriate policies, send $13.95 for "Taking the Bite Out of Insurance," National Insurance Consumer Organization, 121 N. Payne St., Alexandria, Va., 22314.