Calculating Life Insurance Needs
This calculator can be used to estimate life insurance needs based on the user’s income. The calculator requires a total of nine inputs, including:
- The current age of the user, which will be combined with the desired retirement age to determine the number of years the life insurance must provide income
- The user’s annual income, which will be the primary factor the calculator uses to determine the life insurance requirements
- Any fringe benefits provided by the user. For example, if the user has a health care insurance benefit that needs to be considered, enter that value in this place
- A projection of the user’s annual increase to their income. For example, if the user’s income is projected to increase by 2.5% per year, enter that value here
- The monthly personal benefits of the user. This value is used to decrease the life insurance estimate. The calculator assumes the expense would no longer exist if the insured passes away
- The user’s income tax bracket, which is used to determine the net “take home” pay
- If the life insurance proceeds will be invested, enter the expected rate of return on that investment. The higher the rate of return on the invested proceeds, the lower the life insurance requirements
- Finally, if the user has an existing life insurance policy, enter that value here
The calculator then provides the user with three outputs:
- The years of coverage the life insurance will provide to the user’s heirs
- An estimate of the income-based life insurance needs
- The user’s life insurance gap, which is the difference between the estimated life insurance need and the user’s current life insurance in place
Determining life insurance requirements
This calculator can provide an estimate of the user’s life insurance needs and is based on the user’s income. What the calculator does is create a stream of income based on the parameters entered by each user. For example, it subtracts the user’s age from their retirement age to determine how many years of income is needed. In doing so, the calculator replicates the user’s earning power over the course of their career. The user’s heirs would need to set some of the income stream aside for retirement, just as they would if the person survived until retirement.
The calculator also considers the raises in pay the user would receive over the course of their career. For example, a user aged 35 that would like to retire at age 65, would have 30 years of pay raises throughout their career. Someone earning 80,000 working for 30 years receiving a raise of 2.5% per year would have a terminal salary of more than 166,000.
Handling personal expenses and benefits
While it might seem counterintuitive, the calculator subtracts the monthly personal expenses from the life insurance requirement. The assumption is this: expenses such as owning a car, purchasing clothing, and commuting to work would no longer exist after the insured passed away. In addition to a salary, the insured might have fringe benefits through their employer that their heirs might rely on. A good example of such a benefit is health care insurance.
Investment rate of return and income tax brackets
The final two variables the calculator needs to estimate how much life insurance the user should consider holding is the user’s income tax bracket and investment rate of return. The higher the income tax bracket, the lower the insurance requirements. This is because we are simulating net pay, which would be the money after taxes are paid. So, the higher the income tax bracket, the lower the net pay, which also lowers the insurance requirement.
The calculator also assumes the recipient of the insurance proceeds will invest that money. The rate of return also serves to lower the life insurance requirement since the money is received upfront and can earn a return on investment before it is consumed by the user’s heirs.