Have you had your revelation about life insurance yet?
It could be a life-changing event such as having kids that gets you thinking about life insurance. Or maybe it's just some "what if . . ." musing before you or a loved one flies somewhere on a trip.
Whatever the trigger, your next impulse may be to dash out and get some coverage. This is usually the point where you discover that buying life insurance is something that you don't just dash out and buy.
One of the many things you'll have to consider first is whether to buy term insurance or whole life. Some day, the Personal Finance column will delve into this contentious, complicated and rather boring issue, but not today.
Instead, let's just say you're going to buy generic life insurance and you're stuck on another important question, specifically how much coverage you actually need to give your dependants financial security.
Your insurance agent no doubt has some ideas on this, but it's useful to do some thinking on your own so you can compare notes.
Some people immediately look for a rule of thumb in such situations, even though these calculations only produce ballpark estimates. In the case of life insurance, a useful volume called The Insurance Book by Sally Praskey and Helena Moncrieff suggests that you multiply your gross income by five to seven times. If you make $100,000 a year, then that's roughly half to three quarters of a million dollars worth of coverage.
There's a more thorough way to approach the question and it's not all that much work. Start by listing all the major things you'd like an insurance payout to accomplish. Here are some examples supplied by Terry Marlow, president of the Marlow Financial Group in Toronto:
Replace your income: Imagine your survivors managing without your take-home pay coming in regularly. Obviously, life insurance will need to replace your after-tax income for at least a few years. Remember that the family's expenses after you die may be lower because outstanding debts such as a mortgage would be paid off (see below).
Get rid of all debt: Pay off the mortgage first, then eliminate credit card balances, car loans, student loans and lines of credit. As far as the mortgage goes, you're better off addressing the debt through your main life insurance policy than to take out the separate coverage that will undoubtedly be offered by your lender.
Provide a lump-sum amount to pay for your children's university education: This can be a monster expense, especially if you have a few kids. The latest estimates are that it costs close to $10,000 a year for university tuition, books and room and board. Years from now, this amount could easily triple or worse.
Cover the tax obligations you leave behind: Capital gains realized on your investments could generate a tax bill, as could the sale of real estate in some cases.
Now consider all the smaller expenses your survivors will face immediately after you're gone -- the funeral, for example. The Insurance Book says the average cost of a modest funeral, cemetery plot and headstone is between $6,000 and $10,000.
Other costs would include: probate fees, which the provinces charge to pay for your will to be registered with the courts; left-over medical bills related to an illness that preceded your death; and miscellaneous costs your spouse might incur such as moving to a new city or job retraining. You may also want to include some money to allow your spouse to take a leave of absence from work to look after the kids for a while.
If you want to factor inflation into your calculations, The Insurance Book suggests adding an extra 10 per cent to your coverage amount. Remember, it's reasonable to expect that the insurance payout your family receives will be invested in such a way as to generate a return of 5 to 7 per cent in a conservative, diversified portfolio.
An on-line calculator is a great tool for getting a rough estimate of where all these costs leave you in terms of your insurance needs. A good example can be found on a Web site called Free Insurance Quotes.com ( http://www.free-insurance-quotes.com ) .
This calculator asks you to input the annual income your dependants would require, and the number of years they'd need to receive it. As well, you add the annual increase in income you'd like, presumably to counter inflation, and the rate of return you'd expect from investing the insurance payout. You finish by typing in your mortgage balance, outstanding debts, final expenses and your existing amount of coverage.
Once you're finished plugging the numbers in, the calculator will tell you how much you need in coverage. Warning: If you want money put aside for set purposes such as your children's post-secondary education, you'll have to factor this in.
Many people have at least some life insurance coverage as part of their benefits plan at work, often one to two times annual salary. If you have dependants and you're coasting on that amount of coverage, you've likely figured out by now that this isn't enough.