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The benefits of investing in a life insurance policy are vast and apparent, and reflect a noteworthy desire to protect one’s loved-ones from further pain and hardship. But, even if we know we need this insurance, how should we calculate how much cover we require?

The benefits of owning a life insurance policy are vast and apparent, and reflect a noteworthy desire to protect one’s loved-ones from further pain and hardship. But, even if we know we need this insurance, how should we calculate how much cover we require?

Two broad methods to achieve this are - the needs based approach and the, less common, income replacement / human life value approach.

The Needs-Based Approach

This method analyses the family’s needs and objectives in the case of the death or disablement of the breadwinner. It assumes the goal of life insurance is to cover the remaining family members’ immediate expenses after the insured family member’s death, along with their ongoing expenses into the future.

These needs are generally classified in two categories - Immediate needs at death (cash needs) and ongoing family needs (net income needs)

Immediate needs at death

  • Final medical treatment costs
  • Funeral and burial costs
  • Estate settling costs (for example, attorney fees, estate taxes, inheritance taxes)
  • Cost of settling credit card and other debts
  • Readjustment costs (other non-recurring expenses incurred while the family adjusts to loss of income)

Ongoing family needs

  • Dependency period income (income required for the current living expenses of children and dependents, and routine household maintenance)
  • Mortgage payment fund
  • Education fund for children and dependents
  • Life income for the surviving spouse (in the case of one non-working spouse, this fund alleviates the need to produce significant income for a given time period)

Income Replacement / Life-Value Approach

This approach projects the income of an individual from current age, through to expected retirement age (all in full year intervals). A present value based on assumed income return, capital gains, and marginal tax rate is then calculated.


  • Begin with the insured income earner’s gross income [income before tax].
  • Calculate the number of years income you need to replace (e.g. the number of years between the insured’s current age, until expected retirement age)
  • Take into account anticipated salary growth and inflation. Remember, if your family desires to maintain its current standard of living in the event the insured passes away, then accounting for future raises above inflation is not necessary - simplify the equation by solely using a future inflation rate estimate for anticipated growth.

Remember, these calculations are based on income, and may not reflect the financial income needs of your beneficiaries into the future. In one sense this method can overstate your family’s insurance requirements by failing to account for other family assets and sources of income. On the other hand, basing assumptions on income solely fails to account for the actual needs of family members left behind, and means potential lump sum requirements such as funeral costs or mortgage are overlooked.

Using either method you can then determine a discount rate for the insurance proceeds and calculate the present value. The investment of life insurance proceeds should provide returns over time that equal the required sum calculated using your chosen method. Shares, bonds, and other types of investment will offer varying average rates of return. It is advisable to use relatively conservative investment returns when calculating your discount rate - this way you are accounting for lower-than-expected returns, or possible market declines in the future.

It is important to note that some financial advisors do not recommend calculating this present value of future income needs. They argue that future investment returns, and inflation rates, roughly balance each other out. It is also difficult to estimate investment returns potentially quite far into the future.

Whichever method you chose to use, pick up the phone and talk to our consultants at Rate Detective. Give us a call today and enjoy the peace of mind knowing you are one step closer to protecting your family’s future.

At Rate Detective we compare offers from 12 different insurance companies. All the companies on our panel perform medical assessments prior to application, thus ensuring that you do not pay more than necessary for your life insurance.

At Rate Detective our consultants are always available to help you find an affordable life insurance policy. Don’t put it off any longer, pick up the phone and have a chat with us today.