INSURANCE CENTER: Life

What factors might supplement replacement income?

Life Insurance
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After you've figured out your replacement income and you've picked yourself up off the floor, you can stop gathering items for a garage sale and really start to chip away at that figure. (Besides, you're only going to get a few bucks for that dusty Ronco Toe Hair Curler.)

There are three ways for the surviving members of your household to supplement replacement income: Social Security, income, and current savings.

1. Social Security for survivors
You may not realize it, but Uncle Sam is one of the largest life insurers in the land. If you have 10 years or more of employment earnings under your belt, your surviving dependents will probably qualify for a piece of this action. Even with fewer than 10 years of work experience, your family may still get something.

To help you estimate this benefit, the Social Security Administration (SSA) provides an online calculator. In the output from the calculator, scroll down to the table labeled "Survivors." Note that the monthly payment per family is capped. If you have more than one dependent, be sure to use the "Family maximum" figure in place of the per-child amount.

Once you get this monthly income amount, things get a little rocky. Hang on!

First, we're talking here about an adjustment to annual replacement income. In other words, it will send you to a new row in the replacement income table. The problem, however, is that the table is laid out in terms of annual income and the Social Security calculator gives us a monthly amount. So, to adjust Uncle Sammy's contribution to match the table, multiply the monthly amount by 12. This gives you annual replacement income provided by Social Security. Subtract this amount from your current salary, and go back into the replacement income table at this lower annual amount.

Let's extend the example in which your current salary is $40,000 and you are 25 years away from retirement. Without considering Social Security payments, we came up with a table value of $803,000, the amount required to pay your family $40,000 every year for 25 years. Now, tack on the assumption that you have two or more dependent children. (There were a few cold winters back in the '90s, you know.) Given these numbers, the Social Security calculator spits out a rough estimate of $2,245 in pre-tax monthly income (the family maximum). On an annual basis, this equates to roughly $27,000, before taxes.

We then subtract the $27,000 in Social Security benefits from the required $40,000 in annual income, we get a new figure of just $13,000 in replacement income from life insurance. Go to the replacement income table with this new number and see that you are now looking at between $201,000 and $402,000 in term life benefits, less than half as much!

As in this example, adjusting for Social Security survivor payments can substantially reduce the amount of life insurance you need. If you have serious concerns about the reliability of Social Security income, you may want to skip this adjustment or water it down. It's up to you.

If you want a more precise estimate of Social Security survivor benefits, our friends at the Social Security Administration provide additional calculators on their website.

2. Income from your spouse
If your spouse also earns a paycheck and, together, you are easily meeting monthly expenses and planned retirement and college savings contributions, you may want to reduce the amount of insurance you buy. Life insurance should cover needs, not wants, so you may want to start with the replacement income that reflects what you'd really need as opposed to your current household income. The less you pay in premium payments, the more will be added to your investment account. You're more likely to earn money on these savings than you are to ever receive the increased death payment.

If your spouse does not work, but could work, you may also want to reduce your replacement income need . Be conservative, though. You don't want your spouse stressed out searching for a hard-to-find job in the years immediately following your death.

If your spouse is the primary caregiver for dependents, be sure to factor in this cost. In other words, adjust the necessary replacement income only by the amount your spouse will clear, annually, after paying for dependent-care expenses.

If you are the primary caregiver for dependents, be sure to insure your life so that your spouse can meet this expense. For example, if you work part-time and care for your kids in the afternoon, you will need to replace both your part-time income and any ongoing dependent-care expenses your spouse will incur.

3. Current savings
If you have savings -- beyond money earmarked for retirement, college, or other specific plans -- subtract these from your life insurance needs. (This change is made to the final lump sump payment value as opposed to the annual replacement income.)

In a perfect world, you save enough on your own to provide the lump sum life insurance payment from your own savings! This way you could earn investment income rather than pay premiums. While this is an excellent savings goal and a great perspective to take when figuring your life insurance needs, alas, it's not a practical in the short term for most of us.