Life Insurance Needs Analysis (Income Replacement)

How it works

PV of income = (income × % − survivor benefits) × [1 − (1 + r)^−n] ÷ r (r = real return); total need = PV + debts + education + final expenses; gap = total − existing cover − liquid assets

A needs analysis replaces the rough “ten times salary” with what the family would actually require: the after-tax income they depend on, for as many years as they depend on it, discounted at a modest real return because the payout is invested and drawn down; plus lump sums to clear the mortgage and other debts, fund education and cover final expenses; minus what already exists — group cover, savings, and survivor benefits such as Social Security, which for families with young children can be substantial. Using a real (inflation-adjusted) return keeps the income stream level in today’s dollars. Because the need shrinks every year as debts fall and children age, many people ladder two term policies of different lengths rather than buying the full amount for the full term, and they revisit the number at every life change.

Worked example

Replacing 70% of $75,000 less $18,000 of survivor benefits is $34,500 a year; over 20 years at a 2.5% real return that is $538,000. Adding $280,000 of debts, $120,000 for education and $25,000 of final expenses gives $963,000; subtracting $150,000 of existing cover and $90,000 of assets leaves a $723,000 gap — round to $750,000 of 20-year term, roughly $135 a month for a healthy 38-year-old.

Frequently asked questions