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Here's how to figure out how much life and disability insurance you need

The coronavirus pandemic has put many money issues into stark relief: health insurance, job security, the need for emergency savings. Married couples and those with families may be thinking about another financial component that many often avoid: life and disability insurance.

Life insurance provides a payout when the insured person passes, helping widowed spouses and children stay afloat financially. Disability insurance replaces a certain percentage of your income for a specific period if you can’t work because of an injury or illness.

While both are key to a complete financial plan, they are hard to talk about. But the pandemic may be changing that.

“Covid is in our face. There’s a lot of anxiety around and it’s making people be very attentive to their financial well-being,” said Sean Scaturro, advice director at USAA. “Insurance is part of that financial well-being conversation.”

Here’s how to determine how much you need for each.

During the pandemic, some married couples and those with families may be thinking about another financial component that many often avoid: life and disability insurance. (Photo: Getty Creative)
During the pandemic, some married couples and those with families may be thinking about another financial component that many often avoid: life and disability insurance. (Photo: Getty Creative)

How much life insurance do I need?

Start easy by calculating the minimum amount of life insurance you need, Scaturro said. Get enough to pay off all of your debts and cover five years of your income.

If your family can pay off all of their debts, that frees up a lot of cash flow. It also takes some financial strain off surviving family members who are dealing with the emotional toll of loss.

Still, that quick and dirty formula is only a starting point, Scaturro said.

“That’s really for an adequate amount of coverage. It’s not ideal,” he said. “Is it going to replace all of the goals you have as a family indefinitely? Probably not, but is it a good starting point? Yes.”

The next step is to use the acronym, LIFE, to determine your comprehensive needs. That stands for Liabilities, amount of Income needed to be replaced, Final expenses such as funeral arrangements and medical costs, and Extra goals like future education costs or charitable giving.

Start easy by calculating the minimum amount of life insurance you need. Get enough to pay off all of your debts and cover five years of your income. (Photo: Getty Creative)
Start easy by calculating the minimum amount of life insurance you need. Get enough to pay off all of your debts and cover five years of your income. (Photo: Getty Creative)

“When you take those numbers, that’s what your need is,” he said.

If that amount is too expensive for you at first, think of it as a goal to grow into as time goes on and you earn more money. Also, look at your budget and find where you can make sacrifices to increase your coverage.

Pro tip: If you’re a spouse who does not work, that doesn’t mean you don’t need life insurance on yourself. What that spouse provides may not be income, but if not there, you would need to pay someone to replace the work that spouse does.

“If my wife wasn’t here, can I keep working my job with the same hours,” Scaturro said, noting he has children. “Most families can’t.”

How much disability insurance do you need?

Figuring out your disability needs is a bit more complicated. You need to identify what risk you’re comfortable maintaining and what risk you need to transfer, Scaturro said. Disability insurance needs to fill in the gaps that your personal assets can’t cover.

How do you determine this? By answering three main questions.

What do you need? Look at your budget and figure out what the essential expenses are and which ones are discretionary. Be really honest with yourself. Do you really need all those streaming services?

“You know you need to pay for housing, utilities, food. Really box in that cost month in and month out because those need to be addressed first,” Scaturro said. “Then identify what 60% of your income would look like. That is the top of what disability insurance will provide.”

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What do you have already? Count up what you already have, including emergency savings — ideally six months’ worth of expenses — along with any disability, short term or long term, that your employer provides. What does that provide you in case of a disability event?

“If I have an employer policy that will pay 25% of income, but I need 60%, then I have a gap of 35%,” Scaturro said.”That’s what I will be looking for in the insurance market.”

What coverage is best for you? This is where you're looking to close the gaps. For instance, if your employer offers short-term disability but no long-term, then you “need something that covers a life-altering injury,” Scaturro said.

The rule of thumb is that short-term disability insurance usually covers lost income up to a year. Long-term disability can offer income replacement up to age 65 and tops off around 60% of income. It also comes with something called an elimination period, a waiting period before benefits kick in. You’ll need emergency funds of your own to cover that gap.

“The shorter the elimination period, the more expensive the coverage,” Scaturro said. “The longer the window, the more affordable the policy.”

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