Just how much insurance do you need? That's a tough question, but not impossible to answer. In the life insurance business, calculating how much money your family will need if you die is called a "life insurance needs analysis". To properly analyze your family’s situation, complete the following steps. These will be discussed at length in the sections that follow.
The first step is to determine what you have and what you need. Where will the money your survivors need come from? It usually comes from two sources: the capital you have accumulated and life insurance.
What capital do you already have? Calculate what you already have saved in liquid and investment assets, including retirement and personal assets. Remember that retirement assets may not be available to use after death. Pension plan money is usually locked in until at least age 50. Taking money out of RRSPs adds to your income in the year of withdrawal and may create a large tax bill. Further, it is using funds today that were intended for retirement. Your home is an asset, but if your family continues to live in it, it will likely not be available to generate income.
Determine what life insurance you have from all sources. This may include group life insurance from work or an association, life insurance on your loans or private life insurance that you have purchased in the past. Do not include accident insurance, as it is only payable in the event of accidental death (not guaranteed). Add this amount to your other assets.
Your life insurance plus all your assets added together is the total amount available to leave behind for your beneficiaries.
Even in the case of your death, life will go on for your survivors, as will the expenses involved with living and with dealing with your death. The following are some of the immediate cash needs you may want to account for in your planning.
Do you want to ensure there is a pool of cash to pay your last expenses and ease your family’s immediate burden? A "final expense" fund should include money for the funeral, legal, accounting fees, and the administration of your estate. An amount of $10,000 would be a minimum.
You also require funds to pay any income taxes due upon your death. If you only have employment income, then there should be few additional taxes. If you own stocks or investment real estate, Canada Revenue Agency (CRA) will assume you sold them the day that you died and there may be taxes owing on any capital gains.
Your executor will also need money to pay any debts that you have outstanding, including your mortgage. An elimination of the mortgage will allow your family to continue with their lives without the worry of continuing to make these payments. If you have life insurance on your mortgage or other loans, include this amount when adding up your current life insurance coverage.
Do you want to include a sum of money at death that would be set aside to pay for post-secondary education costs? Alternatively, you could include education funding as part of the household’s ongoing living expenses.
You should have an emergency fund in addition to your life insurance. An emergency fund can be set up with specific assets of your estate that you’ve identified to your executor or by obtaining a line of credit secured jointly with your spouse/partner. Life is going to be difficult enough for your family, you don't want to burden them further by not having some cash available to pay for basic living expenses. Set aside between three and six months of expenses in this fund.
Determine what forms of income will continue if you die. Will your spouse/partner continue working or return to work? Add in an estimate for Canada Pension Plan (CPP)/Québec Pension Plan (QPP) survivor benefits that a qualifying spouse/partner and eligible children may receive.
How much of your income will your family need to replace? Do you expect your spouse/partner or children to get jobs? Or do you want to set aside a lump sum of capital that, when invested, will replace your income? How long do you want this lump sum to last, just until your children are independent or for the lifetime of your spouse/partner? Calculating the amount needed requires you to make assumptions regarding the rate of return on the capital invested.
What do you contribute toward the family expenses now? This contribution can be somewhat reduced because the family will no longer have to feed and clothe you. However, some costs may go up if you or your spouse/partner dies. Don’t forget the cost of work currently being performed by a stay-at-home spouse/partner. Housecleaning and child-care costs may need to be added to a working parent’s budget. For a single person with no dependants, there won’t be any ongoing living expenses to include.
Remember, unforeseen factors might affect your family's needs in the coming years, including inflation and unexpected future expenses.
Now you are ready to use the Life Insurance Needs calculator. Enter your personal data to determine if your current life insurance is sufficient to meet your family’s needs. If you have a spouse/partner, run the analysis for each person.A negative result is the amount of additional life insurance that is required.
If the life insurance calculation in the previous step returned a negative result, you may need to consider purchasing some life insurance. In that case, the next steps are to:
As you can see from the number of steps involved in this process, assessing your life insurance needs can be a complicated process. It's also an important one, particularly if you have family who will rely on the insurance after your death. Calculators are useful but professional advice is still necessary to confirm your needs. Once you have a good understanding of life insurance, seek professional advice to confirm your insurance needs.