You’re thinking about getting an insurance to protect your self or your loved ones from anything undesirable that may lead you to cause your income generating capacity, However, you might be in the dilemma of knowing how much insurance coverage do you really need in order to provide full coverage for you and your loved ones.
It might be safe to say that getting a coverage more than what you really need is good but it’s not efficient. You’ll end up paying more premiums, an amount that you could use either for additional savings or investment.
The first way to determine how much insurance coverage do you need is to first assess your annual income and multiply it by 3. If you’re earning $100,000 a year, then you need to get an insurance coverage of at least $300,000. The concept behind this is that in the next three years, either you or your loved ones could still maintain the same lifestyle even if you lose your income.
However, if you have assets, computing for the insurance coverage becomes a little more complicated. An estate tax has to be paid in case of your untimely death and estate tax increase with the value of your investment or assets. If you have a lot of assets, your heirs has to pay more estate tax. The estate always takes a part of a dead man’s properties.
Computing the exact amount of taxes that has to be paid by your heirs in case of your untimely death is a little complicated. However, let’s simplify it and round off digits to make it easier. But before going to the meat of the discussion, let us first answer the question “what is the relationship between getting an insurance coverage and your assets or properties?”.
As mentioned earlier, in case of your untimely death, your heirs must pay an estate tax that is worth a fraction of your total assets. Upon death, all your assets will be frozen and your heirs can’t touch it hence if they aren’t as wealthy as you are or if they don’t have enough money to pay the estate tax, your assets will go to the estate normally after 6 months. This is where insurance comes in, to provide financial support in case of untimely death. Insurance provides direct financial support to your heirs hence they get access to funds to pay the estate tax.
Computing an approximation of your insurance coverage is a pretty straight forward approach. Estate taxes are around 20% of your total assets or properties hence you should get a coverage of at least 20% of your total assets’ worth. For example, if your assets are worth $10 million, you need at least $2 million insurance coverage to ensure your heirs that they get your assets.
However, take note that it still doesn’t include any projected growth of your investments in the future. As a rule of thumb, always increase your coverage by around 10% to 15% from your actual need hence if you need a coverage of $2 million, increase it to around $2.5 million to provide buffer.