What isn't covered by replacement income?
In addition to basic replacement income, you'll need to add a few key costs into your insurance estimate. They are:
1. Immediate family needs
When you die, your family will face funeral costs, legal costs, the potential for uninsured medical costs, and possibly more. Unless you have sufficient liquid savings to cover these expenses, you'll want your life insurance to cover them, since replacement income calculations don't factor in these one-time costs. You don't want your family running out of replacement income early because they blew too much of the insurance payout on the funeral.
A June 2000 government publication estimates average funeral expenses at $6000. It also points out that some funerals go beyond $10,000, however, so be generous. Given the relatively low cost of picking up an extra $25,000 in life insurance, this is not a good place to cut coffins... um, we mean corners. Even if you don't want jugglers and a bagpipe ensemble performing at your funeral, your spouse might, and it's your spouse that you should be thinking about.
2. Debt payments outside of your monthly budget
If your death leaves your family with debt payments, and especially if those payments are beyond the scope of your current monthly budget, you should leave a lump sum to cover the full amount owed.
Many people include home mortgage debt when giving this advice. However, since investing the outstanding balance of your mortgage is likely to return more than the tax-adjusted cost of ongoing monthly interest payments, it's questionable whether this is the right thing to do. In purely financial terms, it may make more sense to include monthly mortgage payments as part of the ongoing costs covered by replacement income.
For you, it comes down to what will make your survivors most comfortable. If you decide to tack on the outstanding mortgage balance so your spouse can clear this debt, though, you may also want to adjust the replacement income required accordingly.
3. Benefits provided by your employer
Be sure to consider the cost of replacing benefits provided by your employer. Some benefits, like health insurance, contribute significantly to your overall income and could be even more expensive for your family to obtain outside of your employer's plan.
4. Additional contributions to savings plans
If your retirement and education savings are behind schedule, or non-existent, you may want to provide additional replacement income to beef them up. Remember, though, this will cost you. Since odds are better that you will not die before retirement, you're probably better off investing this extra premium charge on your own. One major exception to this rule is employer matching of retirement contributions. If these will represent a significant chunk of your spouse's retirement income, you should plan to replace them.