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How do you determine how much insurance you will need?

Determining the amount of insurance that you will need is a three-step process. First, you should add up the value of your assets to estimate how much your estate might be worth at your death. Second, you should calculate your estate obligations at death. Third, you can use the first two calculations to determine the income needs of your survivors. Such an analysis is called a capital needs analysis. The following example may better illustrate how such an analysis is to be conducted.

Mary and Bob are in their late twenties and have two young children. They both earn $60,000 a year. They have a $100,000 mortgage. They place a high value on education and wish to leave their two children $30,000 each. They have $10,000 in the bank and RRSPs of $20,000 each. They also want to set aside an emergency fund. (The rule of thumb is that emergency funds should be three times the total family month gross income – in this case (3 * $120,000)/12 = 30,000.) They do not want to cash in their RRSPs in the event of either of their deaths. They each have $250,000 of term life insurance and group insurance of $250,000 and $300,000, respectively. If you assume that any capital would earn 4% on their death, the amount of insurance that each would require would be calculated as follows:
Assets Available Mary Bob
Cash 10,000 10,000
Personal Life Insurance 250,000 250,000
Group life Insurance 250,000 300,000
CPP/QPP Death Benefits 2,500 2,500
Investment Portfolio
Other Assets
A. Total Cash Available 512,000 562,500
Estate Obligations at Death
Funeral Expenses, Legal/Probate Fees, Unpaid Income Tax 15,000 15,000
Mortgage 100,000 100,000
Education and Emergency 90,000 90,000
B. Total Cash Needed 205,000 205,000
Income Needs of Survivor
Required Gross Monthly Income 3,125 3,125
Less CPP Survivor Payable 421 421
Less CPP Orphan Payments (174.07 per child) 348 348
Total Monthly Income Capital Needed (3125 – 421 – 348) 2,356 2,356
C. Total Income Capital Needed (2356 * 12)/.04 706,800 706,800
Total Additional Insurance Needed (B + C – A) $399,800 349,300
Mary and Bob would need $399,800 and $349,30, respectively, of additional life insurance each.
If the discount rate rises you will need a smaller amount. For instance, if a 5% discount rate were used in the above example rather than 4%, the amount of total income capital needed would be $565,440 instead of $706,800. This is because the returns on your assets would be higher. The above example provides an approximate estimate of how much insurance is appropriate. You should consult your insurance agent to obtain more details about this issue.