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Just as parents-to-be prepare themselves emotionally for the arrival of a new baby, there are financial arrangements that also need to be made. Life insurance is a way to help secure a family’s financial situation if the unthinkable happens. And though it may seem daunting, determining how much of a life insurance benefit is appropriate is relatively easy.

There are primarily two questions that need to be answered when deciding what to buy: What is the need you are trying to cover, and how long will you have the need? The first question helps determine the amount of death benefit necessary, while the second question begins the process of determining the type of life insurance which will be best suited to the insured’s budget and corresponding financial goals. Other questions, such as what coverage options might be appropriate, also need answering, depending on the individual situation. Lastly, the price, quality and performance of the insurance carrier all need to be considered.

How Much Is Appropriate?
The primary purpose of life insurance is to protect a need. The most common needs covered by life insurance include income replacement, debt elimination, final expenses and children’s education. There are situations with other needs, such as covering estate taxes, but for this discussion, we’ll focus on the common needs. Determining the appropriate death benefit should not be based on the perceived value of the person. For example, if your loved-one was taken from you by the actions of a negligent automobile driver, most people would demand millions, but that is different from the actual financial loss.

Income Replacement
If someone is earning an income and sharing it with another (spouse, parent, child), that income can be replaced by the proceeds of the death benefit. Even if the individual doesn’t earn an income, the death benefit can hire a replacement (the most common example is the homemaker, who performs the jobs of nanny, maid, cook, errand runner, etc.). The income replacement portion of the death benefit is there to replace the lost income and/or hire a replacement for the unpaid jobs the insured performed.

There are different ways to calculate the income replacement need. One method, described as Capital Retention, calculates the death benefit needed by an assumed interest rate to arrive at an annual interest equal to the income being replaced. Capital retention is more complicated and requires certain assumptions. Another, called Capital Utilization, calculates the sum needed by multiplying the net income (or cost to hire a replacement) by the number of years it will be needed. If the insured nets $50,000 per year, and you want it replaced for 10 years, the total would be $50,000 X 10, or $500,000. This method doesn’t take into account interest the ($500k) sum would earn, but neither does it account for future inflation or potential salary increases. It’s meant to be simple. Social Security benefits would offset this need, and can be substantial, but not everyone wants to count on them.

Debt Elimination
Most debts are not covered by any death benefit by the lender. The principle balance of mortgages, student loans, credit cards or business loans are usually payable if the person who signed for the loan dies. If there is more than one person on the loan, it must be rewritten upon the death of any of the borrowers.

Final Expenses
These are funeral or medical expenses. The average funeral cost in the US, based on a 1999 survey of the National Funeral Directors Association, was $5,800, not including a cemetery plot.

Education Fund
If you have children, do you want a fund set aside for their education expenses? The current costs of higher education can be obtained from many sources, but as an example, Illinois State University, room/board/tuition is $8,600 per year; Northwestern University is $32,100 per year. Multiplying these numbers by four years gives totals of $34,400 and $128,400, respectively, per child.

Total the Needs
After adding all of the individual needs, subtract savings or other assets which could offset the total death benefit need to arrive at the total.

Every situation is different. Trying to determine what amount and type of policy is needed cannot be covered fully here. Seeking the advice of a licensed expert, or experts, is wise. Try to make certain the agent has your interests at heart, expect them to ask a lot of questions, and give them as much information about your personal situation as possible. If they don’t, find another agent.