A popular approach to buying insurance is based on income replacement. In this approach, a formula of between five and ten times your annual salary is often used to calculate how much coverage you need. Another approach is to purchase insurance based on your individual needs and preferences. The first step is to determine your unique income replacement needs.
Currently, a large portion of your income goes to taxes (insurance benefits are generally income tax free) and to support your own lifestyle. Start off by determining your net earnings after taxes. Then add up all your personal expenses such as food, clothing, magazine subscriptions, club memberships, transportation expenses, etc. The remainder represents annual income that your insurance will need to replace. You'll want a death benefit amount which, when invested, will provide income annually to cover this amount. Then, you should add to that the amounts needed to fund one-time expenses such as college tuition for your children or paying down mortgage or debt.
Income replacement for nonworking spouses is an important and often overlooked insurance need. Coverage should provide for your costs for day care, housekeeping, or nursing care. Add to this any net earnings from part-time employment.
Finally, estimate your own "final expenses" such as estate taxes, uninsured medical costs, and funeral costs.
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