How to assess your life insurance needs

By Ginger Applegarth

What's your life worth? If you've shopped for life insurance, that's sort of what you're trying to find out. Chances are, you've heard different people suggest vastly different calculations on how to reach the right number.

The problem is that every person's situation is different, and although your financial situation may look the same as your colleague's, your needs are different.

MSN Money's Life Insurance Needs Estimator is based on a time-tested method used by reputable agents and financial planners for decades: the capital-needs analysis. The beauty of the capital-needs analysis is that it takes into account the quirks that make you and your situation unique.

Figuring out how much life insurance you need shouldn't be a guessing game. You can assess your needs -- and the needs of your loved ones -- and make a calculated assessment.

The Needs Estimator walks you through typical costs, such as a funeral (the average funeral in the U.S. is now about $7,500 to $8,000, though the true sum can easily be double that once a burial plot, flowers and other costs are included), to the atypical, such as the special-needs slush fund most people should include in their insurance calculations. (A safe estimate is about $25,000 to $30,000 to cover unexpected expenses.)

Most important factor is your dependents

A lot of insurance advice seems to be based on your marital status to determine your insurance needs. That's not exactly the issue. The most important factor is whether you have any dependents -- those who are (or who will be) counting on you to support them, either partially or fully -- and how many dependents you have. Here are other major factors to consider:

• The kind of lifestyle you want to provide for your family.

• Your nonworking spouse, who wouldn't have an income if you died.

• Your working spouse, who would "retire" to raise your children if you died.

• Other sources of household income, such as a second paycheck.

• Any debts that you want paid off, such as a mortgage, car loan or credit card.

• Your family's college expenses.

• Any special needs, such as a disabled child or a child who will never be self-supporting.

• Your parents, who may eventually become financially dependent on you.

Even if you're wealthy and think you don't need coverage, think again. Does your taxable estate approach $1 million if you're single, or $2 million if you're married? If your estate doesn't have enough liquid assets to pay estate taxes, you need more insurance. The Internal Revenue Service will want cash from your estate within nine months, and you might have to invest in a life insurance policy to swing this. However, the estate tax is scheduled to be repealed for one year only in 2010 (See "2010: The best year to die?").

Video: A retirement reality check

Childless now, but what about the future?

If you're married and don't have children, you may still need insurance. If your spouse can live on his or her income alone and you don't have a mortgage (or don't care whether it's ever paid off), your only need may be to cover any final expenses incurred at your death.

But consider the possibility that your parents may depend on you in the future, or that you may want to help pay for college costs for a family member (a niece or nephew, for example).

Divorced people, singles

Divorced people have special insurance needs. If you fall into that category, you'd better dig out your divorce agreement. It may stipulate that you have to keep a certain amount of life insurance in force for your ex-spouse or to pay your part of your children's education. Even if your divorce agreement doesn't require it, if you have children, you should have life insurance in order to cover your part of their college costs, and possibly to leave them an inheritance.

Single people are often told that they don't need insurance, or that the small policy that comes with their work benefits is enough. In many cases, that's absolutely right. If you lead a simple life with no mortgage and no significant other, a life insurance policy may just be an unnecessary expense.

There are certain instances where you may need it, however. If one of these scenarios applies to you, start thinking about life insurance:

• You have a mortgage that is more than the value of your house.

• A relative has co-signed on your mortgage and would suddenly be stuck with your payments.

• You have a partner, friend or relative to whom you want to leave money.

• You bought a house with your live-in partner, and you have an agreement that each person's share of the mortgage is to be paid off upon his or her death.

• Your parents won't be able to manage financially if you're not around.

• You want to leave money to a charity or other nonprofit organization.

Updated Dec. 7, 2009