February 9, 2022

Do I Have Enough Life Insurance?

In Insurance, Wealth Strategy

Melissa Franco
Contributions from: Melissa Franco

Life insurance plays an important role in your financial plan by continuing to provide for your spouse and children in the event of your unexpected passing.  For business owners, life insurance can protect the value of your business if you pass, and for those with large estates, life insurance can help offset future estate tax.  Proper life insurance coverage should provide you with peace of mind.  Here are our suggestions on how to evaluate coverage and determine how much life insurance is needed for your financial situation.

Why Do I Need Life Insurance?

If you died today, would your spouse have enough money to pay the bills without selling your home or other assets, or borrowing money?  Could your spouse maintain your current standard of living, send your kids to college, and retire comfortably?

Life insurance provides cash benefits, generally free of income-tax, which could help your family avoid difficult or costly choices.  Cash can help pay off debt, build a college fund, or provide a nest egg for your children.  Furthermore, life insurance can replace lost income that can maintain your family’s standard of living after your death.  Your lifetime earning potential is probably the single biggest asset you own.  By replacing your income if you die prematurely, or before enough assets have been accumulated to satisfy your financial goals, life insurance can be the ultimate safety net.

How Much Coverage Do I Need?

A commonly used rule of thumb is to purchase life insurance benefits equal to 10 times gross income.  Here are additional methods for calculating how much life insurance you should purchase:

The ‘Spend Down’ Approach

In the Spend Down approach, the primary goal is to spend down a specific amount of money over time.  This is intended to provide financial support for a chosen number of years.  Begin by determining a specified support period usually corresponding to a milestone event (for example, 15 years until your children graduate from college).  Next, calculate the difference between what your dependents would have if you were to pass away today, and the amount they would need to cover expenses over this time period.  Your new policy should come as close to making up the difference as you can afford.

The ’Income Replacement’ Approach

In the Income Replacement approach, the insurance proceeds are used to establish an investment account with the objective to create a lifetime income stream for the survivor.  First, determine an annual spending goal for your family.  Then calculate a starting account balance that incorporates your existing cash and investments plus insurance proceeds and determine what amount will produce an income stream equal to your annual spending goal.  Take into account potential Social Security benefits and stock options that may automatically vest upon death.  Use modest return assumptions (e.g., 3-4%) to compensate for inflation and underperforming market cycles.

In calculating what you need, consider the following:

  • Pay off mortgage — Consider whether your family would want to pay off your mortgage with the life insurance proceeds. Doing this eliminates a large monthly expense.
  • Pay off other debt — After the mortgage, there may be other sizeable debts that should also be cleared, like car loans, student loans, etc.
  • Set aside college costs — Using life insurance proceeds to fund college expenses frees your surviving spouse from worrying about how they are going to pay for this big-ticket item.
  • Set aside living expenses — Part of the proceeds can be used to cover current and future living expenses. How much do you spend each month?  How much do you save each month?  You can adjust the amount needed depending on variables such as your spouse’s current or future income, how long he or she needs the income, and so on.
  • Fund final expenses — Your family may bear the burden of expensive funeral costs or medical bills.

Types of Life Insurance

Most life insurance policies come in two basic categories, term and permanent.


Term life insurance provides coverage for a specific period, often 10, 15, or 20 years, and is generally less expensive.  If you die during the coverage period, your beneficiary receives the policy death benefit.  If you live to the end of the term, the policy simply terminates.  Term coverage is designed to protect your family from the loss of your income.

A $5M term life insurance policy where the premium is fixed for 20 years may cost $2,500 – $3,000 per year for a 35-year-old in good health.  This same policy may cost $5,000 – $6,500 per year for a 45-year-old in good health.


Permanent life insurance provides coverage as long as you live, which makes it more useful for estate planning.  Premium payments are higher than term policies as the premium covers the life insurance benefit and builds a cash reserve.  Should you discontinue the policy, this reserve, known as the cash value, is returned to you, subject to surrender charges.  Permanent life insurance policies come in two categories:  whole and universal.

Whole life:  The premium amount is generally level (equal) for life.  The death benefit and minimum cash value are predetermined and guaranteed.

Universal life:  The premium amount is flexible, the death benefit is generally not guaranteed, and the cash value will grow at a declared interest rate less policy expenses, which may vary over time.  A Variable Universal life policy includes an investment component, where the death benefit fluctuates based on the value of the underlying investments chosen.  These types of life insurance policies may not be optimal to protect your family from the loss of your income because of these uncertainties.

Other Life Insurance Uses


Currently the Federal estate tax exemption amount is $12.06M per person.  However, under the Tax Cuts and Jobs Act of 2017, the exemption amount is scheduled to “sunset” or return to $5.49M per person (adjusted for inflation) after 2025.  Second-to-Die life insurance policies provide benefits to beneficiaries only after the last surviving person on the policy dies.  Insurance proceeds are received free of income-tax and can also be free of estate-tax, if properly arranged.  Second-to-die insurance policies, also known as survivorship policies, may be less expensive than traditional life insurance plans, but are typically only used for estate tax protection.  The surviving partner won’t receive any benefits during their lifetime.


When a business partner passes away unexpectedly, it can be difficult to buy that partner out of the business and compensate her or his family for the value of their ownership.  Life insurance proceeds can help provide the cash flow required to continue operating the business and provide cash for the buy-out.

Reviewing your business legal agreements is also a critical planning component.  Your Buy-Sell Agreement should clearly outline the valuation process, including the valuation calculation method and timing of buy-out in the event of death or disability.  The calculation formula may be 1) a fixed buy-out amount adjusted annually, 2) a multiple of earnings or other agreed-upon valuation method or 3) a professional valuation done at the time of death.

To calculate the amount of insurance needed to protect the business, determine how much debt the company is willing to take on and how much insurance you need to guarantee the payments.  The ownership of these policies should be carefully considered.

How Often Should I Review My Life Insurance Coverage?

Life insurance is a valuable tool to protect your loved ones and plays an important role in your long-term financial plan.  If you don’t already have suitable life insurance policies in place, reach out to your Coldstream wealth management team for help in reviewing your options.  As your wealth grows, your life insurance needs will change, so it’s important to review coverage every 3-5 years.

Insights Tags

Related Articles

November 14, 2023

Bundling Charitable Contributions to Maximize your Tax Benefits

If you’re reading this article, it’s likely you are charitably inclined, value giving back to the community, and attend fund-raising events for the causes most important to you. Now picture this… you are sitting at a table for your favorite annual gala – the time has come to fill out your donation form and write [...]

Vonie Bright
Contributions from: Vonie Bright, CFP®

November 14, 2023

Tips for Microsoft Open Enrollment

Open Enrollment at Microsoft begins in early November. The following is a summary of elections to consider, and as always, please reach out to your Coldstream advisory team if you have questions. HSA (Health Savings Account) If you choose an HSA eligible health plan, you can modify your HSA elections at any point during the year, [...]

David McintoshAlex McBain
Contributions from: David McIntosh, CFP®, Alex McBain

November 14, 2023

Uncle Sam, Here I Come

The 2022 tax period came to an end on October 15th, and we know the last thing you want to think about is our good old friend, Uncle Sam, but hear us out! He extended his stay through October 15th and maybe took more of your time and money than you anticipated. And he’ll come [...]

Contributions from: Colby Stirrat, CFP®