How Much Life Insurance Do You Really Need? – Avoid Overpaying or Underinsuring

Not sure what type, how much cover or if you even need insurance?

One of the primary concerns when you're looking to take out life cover is figuring out how much coverage you actually need. Weighing up all your current and future expenses that  need to be covered in the event that you were to pass away can be quite daunting. Generally it's a process of identifying assets, income needs and future expenses (those that may arise further down the track). This article will outline some key expenses that you should be considering when determining an appropriate amount of cover.

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Quick formula to get an estimate for how much cover to take out

The following formula provides you with a quick guide on calculating a cover amount based on your needs and personal circumstances:

Life Insurance Calculator Formula

Outstanding debts to cover

Personal assets can be recognised as debts that will need to be serviced in the event that you pass away. Each year, families are left devastated not only by the loss of a loved one but the newly acquired debt they must cover following their passing. Determining an appropriate amount of cover will involve looking at and debt currently owing on:

  • Your mortgage debt. Not restricted to your current home, consider investment property and holiday homes.
  • Any outstanding loans. May include any personal loans, investment loans, business loans and car loans.
  • Existing credit products. Consider money owing on credit card and charge accounts.

Replacing your loss of income

Finding an appropriate level of cover will involve considering all of the current expenses that your current income covers and would need to be maintained if you were to suddenly to pass away. These expenses include:

  • Annual living costs. Food, clothing, bills, taxes, school fees, petrol, etc.
  • Any investments you may have. Consider property or any other investments that you currently had. Would you want these to be maintained for your surviving family members if you were to pass away?
  • Homemaker duties. Consider how much it could cost to cover the unpaid duties that you regularly carry out throughout the home. The cost of home maintenance, housekeeping and child minding can come as a great shock to many.

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Do you already have assets or savings that can also be used?

It's important for you to consider all sources of income that your family members may be entitled to after you're gone. This may include:

  • Current savings
  • Employer benefits
  • Investments currently held
  • Funds accumulated in superannuation

Types of insurance to consider

It is ironic that most people won’t have any second thoughts to have insurance for their cars, homes, and health but overlook some of the most important things in life. Things like protecting your family and your income in the event of illness, disability, and sudden death.

Below is a list of the most important types of insurance you need to consider when thinking of your income and your family:

  • Life insurance. Life insurance is a protection for your family. Basically, it protects the beneficiaries from financial stress in the event of death or severe physical injury of the insured. Moreover it can also be used as an investment tool or an emergency loan while you are alive.
  • Income protection. Income protection gives you coverage when you are unable to work due to severe illness or extreme physical injury. Whether you are single or not, it is wise to have something to depend on when something unfortunate happens. Income protection can help you cope financially because it pays you up to 75% of your income. It covers you until such time you are ready to re-enter the workforce or until the retirement age in cases where there is total disability.
  • Critical illness insurance. Critical illness insurance helps ease the financial stress and burden brought about by a terminal illness by paying you a tax-free lump sum. This insurance covers the time you are diagnosed with a certain critical illness until you have fully recuperated. Although not all types of illnesses are covered, it covers the most common terminal illness such as, cancer, kidney failure, major organ transplant, and multiple sclerosis. Getting this kind of insurance is necessary because it could boost your finances in times of emotional and financial hardship.
  • Total permanent disability (TPD). Total permanent disability insurance acts as a safety net in the event of an accident which results in total disability. It also pays you a lump sum to replace any lost income in the future because of your inability to work due to permanent disability. This should not be confused with income protection because this pays only when you have total disability.

What premium is right for you?

When shopping around for the perfect policy, it is common that most would be deluged by unfamiliar insurance jargon. This unfamiliarity could lead to getting the incorrect policy for you and your family.
In order to purchase the right policy that would complement your needs, you should know which type of premium you want for your insurance. For starters, there are just basically three kinds of premiums:

  • Stepped Premiums. These are calculated on a person’s age. Thus, the younger you start with a stepped premium the cheaper it is. However, as your age increases so does your premium.
  • Level Premiums. These premiums work the exact opposite as stepped premiums. Here, you tend to pay much higher at the beginning but becomes less as you grow older.
  • Hybrid Premiums. Hybrid premiums begin increase until a pre-determined age until levelling off. This option is not offered by all insurers.

If we just focus on the starting point, a stepped premium may seem to have the advantage because it is much cheaper. But if you think about insurance on a long term basis, you would see the wisdom of having a level premium.

Income Protection Stepped and Level Premiums

Learn more about how stepped and level premiums work

How much life insurance can I actually apply for?

Maximum Sum Insured

The amount of life cover available to policyholders can take out will be dependent on both their situation and the policy they decide to go with. Many life insurance policies will offer a maximum-sum insured on policies, which can be adjusted depending on the applicant’s age, occupation and other personal features. Other policies will enable policy applicants to take out as much cover, as they desire.

Maximum Cover for Additional Benefits

Additional benefits will often have a maximum benefit amount that is applied. As an example, the Zurich Protection Plus - Death Cover plan will provide an advanced funeral expenses benefit to a maximum of $15,000.

Maximum Sum Insured for TPD

Life insurance underwriters will closely consider the amount of cover applied for TPD plan does not surpass what they would be entitled to if they remained in employment. Put simply, life companies do not want claim payments to result in policy owners “milking” the system be being entitled to more than they would be if they were to stay working.

Maximum Sum Insured for Trauma

Similar to TPD, applicants for Trauma Insurance will have to be able to justify their reasoning behind taking out a high amount of cover. It is not just enough for the policy owner to be able to afford the premiums, they must show why their situation requires such a substantial benefit payment. Most policies will only offer up to $2 million in cover.

What could impact the amount of cover that I can take out?

  • Your age
  • Your occupation
  • Any pre-existing conditions that you may have
  • Dangerous pastimes/hobbies that you are involved in

Some common life insurance myths

Despite knowing the benefits that life insurance can bring them, people still procrastinate in getting one. Two of the most common reasons why people don’t buy insurance would be it is too expensive for their budget and too complicated for them to understand. Furthermore, there are a lot of myths and black propaganda that has circled over the years against life insurance. To separate fact from fiction, it is best to look into them closely.

Myth #1: Insurance through superannuation is enough.

Because it offers a lot of tax concessions, most Australians opt to purchase life insurance through their superannuation. However, most are also not aware that insurance in their super is set at default unless they actively pursue it. This means that the coverage under default insurance is usually quite low and may not be enough.

Some of the benefits you can get from purchasing insurance through your super are the ability to use your super funds to pay for the premiums instead of purchasing a separate policy and the possibility of availing Government co-contribution. You can also qualify for a tax offset when making contributions on your spouse’s behalf. Furthermore, dependents can receive a tax-free lump sum in the event of the insured’s death.

However, despite the benefits and tax concessions you can get from purchasing insurance through your super, just make sure that the level of cover it provides is enough and complements your needs and your family’s. You might also want to know if there is a continuation option available when you have to leave your employer.

Myth #2: I am not employed so don't need cover.

Another alibi that may come into play for not purchasing life insurance is being just a stay-at-home parent. Most people would think that staying at home exposes them to lesser risk than when at the workplace. This may be true but the loss of a homemaker can also put the family unit under great financial strain. Some costs that may be incurred following this loss include;

  • Childcare
  • Home maintenance costs
  • Meal preparation

Myth #2: I am not employed so don't need cover.

Another alibi that may come into play for not purchasing life insurance is being just a stay-at-home parent. Most people would think that staying at home exposes them to lesser risk than when at the workplace. This may be true but the loss of a homemaker can also put the family unit under great financial strain. Some costs that may be incurred following this loss include;

  • Childcare
  • Home maintenance costs
  • Meal preparation

Myth #3: I am young and healthy so why get cover?

It is understandable that a young person without any debts won’t give any thoughts in purchasing insurance. However, the risks that a married and a single person face are the same. A young, debt-free person may not get comprehensive insurance, but he could surely consider getting one that would provide a steady flow of income when an accident or illness occur and would render him unable to work for an extended period.

Myth #5: Insurance companies never pay.

It is understandable that a young person without any debts won’t give any thoughts in purchasing insurance. However, the risks that a married and a single person face are the same. A young, debt-free person may not get comprehensive insurance, but he could surely consider getting one that would provide a steady flow of income when an accident or illness occur and would render him unable to work for an extended period.

Getting the right level of cover is critical

It’s scary reality that approximately 95% of Australians with dependent children do not have sufficient life cover in place. Many people will rely on the default level of cover provided in their superannuation but fail to actually due to calculations to determine how much they would actually be entitled to in the event of their death. It is critical for all Australians to closely consider how much cover they actually have in place and have a clear understanding of what would be needed to be covered following their death.

*The information provided on this page should only be used to help you determine a rough estimate of the amount of cover you may require. finder.com.au recommends you consult an adviser prior to taking out cover if you need assistance in determining an adequate amount of cover.

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Coverage is the amount of money that you will be paid in the event of a claim. An insurance consultant can help you determine an appropriate amount. Calculator
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