What is income replacement?
Income replacement coverage establishes security against loss by providing funds to repay personal debt and continue income. This type of planning is essential in maintaining a current lifestyle.
How much income replacement do I need?
Everyone’s situation is different. There is definitely no tried and true answer to this question. There are many factors that come into play regarding how much income replacement protection should be purchased.
Again, the purpose of income replacement is to allow family members the ability to pay the bills and live their lives as planned despite the death of a breadwinner. Here are some of the expenses that need to be accounted for:
- Final expenses – A funeral, burial and related expenses tend to cost from $10,000- $20,000. You can use $15,000 as a ballpark figure.
- Mortgage and debts – You should total your mortgage balance, car loans, student loans and any other debts that would be left to your survivors. All the debts may not need to be paid off, especially in the case of a loan interest mortgage.
- Future Education Expenses- This is another figure that can sometimes be hard to determine, but it’s best to calculate what college costs will grow to by using a college expense calculator. Will they attend private or public? Will you need to pay full tuition or partial? Are scholarships available or will they use loans?
- Actual loss of income- A good rule of thumb is around 6-10 times gross income? Again, this is a rule of thumb and everyone’s situation is different. So, for someone that was earning $100,000 per year then $1,000,000 of income replacement is a good place to start. If their is a pension then perhaps you lower the amount. If the spouse will continue to earn a substantial salary then the amount can be adjusted.
- Time Factor – How long will the coverage be needed. Are you just started out in life where future raises will affect your income? Also, don’t forget to factor in the cost of inflation. A $1,000,000 policy today will not be worth $1,000,000 15 years from now.
Other factors to consider for income replacement
Other factors that individuals should consider for income replacement are:
- Are you planning on more children?
- Are you thinking about making any new major purchases like dream home, lake house, RV, property?
- Are you concerned with long term care needs or future long term care expenses?
What type of coverage is best for income replacement?
Term life insurance coverage will give you the most bang for your buck. Guaranteed level term life allows you to purchase large amounts of life insurance protection for the lowest cost. You can check out affordable rates here.
It can sometimes make sense to combine low cost affordable term life coverage with permanent life protection. This can be especially true if a couple is young and healthy. The actual cost for a permanent policy may not be much higher than a term life policy.
A permanent type of policy can allow someone to begin building tax-deferred cash values. These cash values can help supplement retirement at a later age. In addition, the tax-deferred growth inside the permanent policy can be accessed on a tax-free basis.
It is also important to keep in mind that term insurance is a temporary plan of protection. This is one of the reasons term life insurance is relatively inexpensive.
At some point in the future the rates on term insurance will begin to increase, sometimes dramatically. You want to be sure that the coverage you purchase will be there when and if it is needed. Permanent coverage can last a lifetime.
One other advantage of permanent insurance that you need to be aware of is the risk of a health change. With a permanent plan of protection there is no need to worry about losing coverage if someone has a change in health.
Term policies that come to the end of the term without a conversion option will be subject to new medical evidence of insurability. This means any health changes since the original policy was issued will come in to play in determining if affordable rates are available.
As an example, an individual at age 30 purchases $1,000,000 of 10 year level term. Now, 10 years later at the age of 40 his original level term period is expiring. He decides to apply for new coverage for another 10 years. But, he was diagnosed with diabetes 3 years ago. His diabetes may keep him from securing affordable coverage, or perhaps any coverage.
How much income replacement coverage will the company let me buy?
Typically, insurance carries will let you purchase income replacement coverage up to the following guidelines:
- Adults to age 30- Up to 30 times earned income
- ages 30-39- Up to 25 times earned income
- ages 40-49 Up to 20 times earned income
- ages 50-59 Up to 15 times earned income
- ages 60-64 Up to 10 times earned income
- ages 65 + Up to 5 times earned income
Most will also take into consideration up to 3 times unearned income
If you would like to look at your options for income replacement life insurance, please contact us at 1-888-393-9003 or mike@specialriskterm.com
