Yesterday, I wrote about the criteria that needs to be considered when calculating life insurance needs. Today, I'm going to calculate our personal requirement for life insurance in case the worst happens.
Note that the insurance requirements for each spouse would be different if one spouse made significantly more money than the other spouse. However, in our household, we make approximately the same income.
So looking through those criteria, here is what our financial picture would look like if one spouse were to pass:
- Existing Life Insurance Benefit: $100k
- Household After Tax Income: $3,200/mo
- Portfolio value: $100k
- Debt load if one spouse were to pass: $210k (mortgage and heloc)
- Household Expenses: $2,900/mo (no mortgage/rrsp contributions/1 car eliminated)
- Ongoing Childcare Expenses (20 years): $1,000/mo
- Education fund: $40k
- Funeral Expenses: $10k (CPP pays $2,500 upon death)
Lump Sum Debt
So first, we need to cover our big debts which include our future mortgage and HELOC of $210k an education fund of $40k and 10k funeral, making our lump sum debt of $260k.
Cash Flow Requirements
The next coverage we need to look at is cash flow. Will the surviving spouse make enough in regular and portfolio income to cover the monthly expenses?
If not, the insurance benefit should make up the difference. For us, expenses would be around $3,900/month including child care expenses. This leaves us with a cash flow deficit of around $700 / month.
We'll assume that salary raises match inflation and the insurance proceeds are reinvested in a non-registered portfolio and/or savings account.
Total Life Insurance Required
Right off the bat, we need a $160k lump sum pay out after the existing $100k life insurance is accounted for.
The $700/month or $8,400/year shortfall must be covered though a combination of the existing portfolio/cash and additional insurance. Also note that income provided from a portfolio is taxable, thus must be accounted for in the calculations.
Our $100k portfolio/cash would hopefully be invested in growing dividend paying stocks (growing at the rate of inflation) paying out an average of 2.8% (after tax) or 3.5% before tax (NL tax rates). This would bring in an additional $2,800/year initially leaving a shortfall of around $5,600/yr.
The shortfall lump sum amount required can be calculated with a couple of methods.
- Use all of the lump sum payout over 20 years: $5,600 x number of years required (20 years for us) = $112,000 (invested in a high interest rate savings account to counter inflation).
- Keep the insurance proceeds for life: $5,600/0.028 which pays dividends based on the payout = $200,000
Adding everything up:
$160k lump sum + $112k for cash flow supplement = ~$272k (no insurance benefit left 20 years after payout)
$160k lump sum + $200k for cash flow supplement = ~$360k (insurance benefit remains intact)
Note that the insurance requirements would be even less should we decide to deplete our $100k portfolio/cash to $0 after 20 years instead of trying to keep the capital in tact. However, I would feel more secure knowing that my wife would have an additional growing income stream for life.
Of course, as our net worth and savings grow, we will be less and less dependent on life insurance to financially protect our family. Our plan is that in 20 years when our term life expires, we'll hopefully be completely self insured. As of right now, we'll most likely be going with the lower amount of coverage.
If you are wondering how much life insurance you should have, go through the steps that I did, OR punch the numbers into a life insurance calculator (like the one on Kanetix) (not aff).
The key point is that life insurance is to protect dependents against financial hardship not to make anyone rich.
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