Do I need life insurance and if so how much?
by Chris Clare

This is a question that is often asked of me as a financial advisor and one that is very simple to answer.

In order to establish if someone needs life insurance you first need to ask yourself a very simple question. In the event I die will anyone be financially worse off?

The term "someone" means anyone who may be financially connected to you such as your mortgage company, a dependent relative such as a child or spouse or in some cases a business partner. In short it just means in the event of death if someone connected to you is impacted financially then you need life insurance.

So before we look at family protection lets deal with the most common need for life insurance and that is to cover a lending institution such as a mortgage company.

When you take out a loan on a property such as a mortgage the lender invariably wants you to insure the debt in the event that you die. So if you have a debt of say 120k for 25 years, the insurance that you would arrange based on the questions above would be term insurance for 25 years with a sum assured of 120k therefore ensuring that if you died, during the 25 year term of the debt, there would be a lump sum sufficient to repay the lender in full.

Now family protection, this is probably the second most common type of protection but in my opinion by far the most important. Why? Well, because it is for the benefit of your love ones. What is the point of working to build up a lifestyle for you and your loved ones, for them to only lose it in the event that you were to die?

Actually putting a figure on what is needed for family protection is somewhat more difficult than the mortgage life insurance. To do it you need to work out what would be the financial impact of the life assured not being around. The best way to do this is looking at the salary that the person brings into the house. On the basis that most if not all people live to their means it would be fair to say that the financial impact of them dying would be the whole and total loss of their salary. So if you earn 20k per annum then you would need some sort of life insurance plan that would pay out a sum equal or greater than 20kpa to be of any benefit. If you could not find a plan that would generate an annual or monthly income amount you would need to consider taking out life insurance for a fixed lump sum of money.

If you do need to arrange a lump sum insurance plan you will need to know how big a lump sum is necessary. Whilst there are a lot of calculators on the internet designed to give you an idea of how much you would need in order to generate an income of a set amount, they do rely on assumptions of investment growth and inflation. However it is not considered unacceptable to taker out a lump sum for about a multiple of ten of what is required as an income. So in this example you would need a lump sum life insurance plan for 200,000k. This theoretically in turn could be invested to possible generate the 20k per annum into the future as income.

To bring all this together you only need life insurance if someone is financially worse off in the event of your death and the amount needed for that life insurance is the amount of financial impact created as a result of that death.
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Articles from November 2007
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