Key takeaways
– The needs approach determines how much life insurance you should buy by totaling the financial needs your survivors would face after your death (final expenses, outstanding debts, income replacement, education, etc.) and subtracting resources already available (savings, investments, existing insurance).
– It’s practical and flexible: you build a budget of one‑time and ongoing needs, then decide how long income should be replaced and whether to use inflation/discounting.
– Steps: list needs, estimate dollar amounts and time horizons, subtract existing resources, choose a policy and revisit regularly.
– The needs approach differs from the human‑life (income multiple) approach, which estimates the present value of future earnings rather than a specific survivor budget.
What the needs approach is (plain language)
The needs approach is a budgeting method used to set a life‑insurance target based on what your survivors will actually need if you die. Instead of using a fixed multiple of income, it builds a list of expenses and goals — both one‑time and ongoing — then subtracts the assets and insurance already available to cover them. The result is the approximate amount of new life insurance to purchase.
Core components to include
1. One‑time (lump‑sum) needs
– Final expenses (funeral and burial/memorial costs)
– Estate settlement and legal fees
– Debt payoff (mortgage balance, car loans, credit cards, personal loans)
– Business obligations (buy‑sell funding, business debts)
– Immediate liquidity needs for surviving household
2. Ongoing (income replacement) needs
– Household living expenses (housing, food, utilities, transportation)
– Childcare and children’s living costs
– Spousal income needs (partial replacement if spouse works)
– Future education costs for children (college tuition)
– Health care and eldercare needs for dependents
3. Longer‑term goals and contingencies
– Funding a spouse’s retirement shortfall
– Child’s future needs (home down payment, graduate school)
– Emergency fund / cushion for unexpected costs
– Taxes and inflation considerations (estate taxes, income tax on certain assets)
4. Resources to subtract
– Existing life insurance (group or individual)
– Savings and investment accounts (cash, brokerage, retirement accounts — note taxability)
– Other assets that can be liquidated (some home equity, business value)
– Social Security survivor benefits or pension survivor annuities (estimate conservatively)
Step‑by‑step practical method (how to calculate your target)
1. Gather documents:
– Recent pay stubs, tax returns, mortgage and loan statements, account balances, retirement statements, current life policies, school cost estimates.
2. Estimate lump‑sum needs:
– Add funeral costs, outstanding debts you want paid off, estate expenses, business costs, and any one‑time obligations.
3. Estimate annual income replacement:
– Decide how much of current income needs replacement (e.g., 60–80% of pre‑tax income) and for how many years (until children are independent, spouse retires, etc.).
– Multiply annual replacement need by the number of years you expect it to be required (or apply a present‑value calculation if you prefer a discounted approach).
4. Add future lump needs:
– Project college costs and other large future outlays; discount or include as nominal lump sums at today’s dollars plus estimated inflation.
5. Total all needs:
– Sum one‑time needs, the present value (or nominal total) of income replacement, and future lump needs.
6. Subtract available resources:
– Subtract savings, investments, current life insurance, and reasonably expected government or employer survivor benefits.
7. Final number:
– The remainder is the target amount of life insurance to buy. Round up to a convenient policy amount and add a cushion (10–20%) to account for underestimation and inflation.
Simple worked example
Assumptions (hypothetical):
– Outstanding mortgage and debts to be paid: $200,000
– Final expenses and legal fees: $15,000
– Childrens’ college fund needed (total): $100,000
– Income replacement: Want to replace $48,000/year for 20 years = $960,000
– Current savings and existing insurance available: $200,000
Calculation:
– Total needs = $200,000 + $15,000 + $100,000 + $960,000 = $1,275,000
– Minus resources $200,000 = Required new insurance ≈ $1,075,000
Actionable decision: Consider buying a $1.1 million policy (rounding up and adding cushion).
Notes about discounting and inflation
– The simple multiplication above treats future income needs in nominal (today’s) dollars. A more precise approach discounts future payments to present value using a reasonable interest/return rate and adjusts for expected inflation. For most consumers, a nominal approach with a conservative cushion is easier and often sufficient.
Comparing needs approach vs human‑life value approach
– Needs approach: Bottom‑up, survivor budget‑based. Good when you have specific goals and debts to cover and want a policy tailored to family needs.
– Human‑life value (income multiple) approach: Top‑down; calculates the present value of expected future earnings and typically produces a multiple of income. Simpler, but may over/underestimate if family expenses are atypical.
– Both approaches can be used together: use the needs approach for a baseline and the human‑life value as a cross check.
Choosing policy type using needs results
– Term life: Best if you need coverage for a defined period (mortgage, children dependent). Lower cost for high coverage amounts over limited years.
– Whole life / permanent (universal, variable universal): Consider if you need lifelong coverage, estate liquidity, or a savings component; more expensive.
– Hybrid strategies: Purchase a large term policy to cover near‑term needs (income, mortgage) and a smaller permanent policy for estate planning or lifelong obligations.
Practical tips and checklist
– Overestimate slightly. It’s safer to err on the high side to account for inflation and unknowns.
– Be realistic about resources: Don’t count assets that are illiquid or heavily tax‑penalized unless you plan to use them.
– Include survivor benefits conservatively: Employer group policies may end or be insufficient.
– Revisit the calculation after major life changes: marriage, birth/adoption, divorce, new mortgage, job change, business sale, retirement.
– Consider staged coverage: large term coverage early (when obligations peak), scaled down later or kept with a smaller permanent policy.
– Shop and compare quotes from multiple insurers and consider the financial strength of carriers.
When to review or update
– At least every 3–5 years or after major life events (marriage, birth, home purchase, career change, serious illness, divorce, inheritance).
– When interest rates, inflation expectations, or your household budget materially change.
Pros and cons of the needs approach
Pros:
– Tailored to real survivor expenses and goals.
– Transparent and easy to explain to family.
– Helps prioritize what needs insurance vs what can be covered by savings.
Cons:
– Requires time and data gathering.
– Some future costs (inflation, health care) are uncertain; may need conservative assumptions.
– May result in a large number that seems unaffordable; consider phased or hybrid solutions.
Next steps (practical action plan)
1. Gather financial statements and list debts, assets, and current policies.
2. Build the needs list (one‑time, ongoing, future) and estimate amounts and timeframes.
3. Subtract resources to get a coverage target.
4. Decide on term length or permanent coverage and obtain multiple quotes.
5. Name/update beneficiaries and ensure employer policies are documented.
6. Schedule regular reviews (every 3–5 years or after major events).
Sources and further reading
– “Needs Approach,” Investopedia. https://www.investopedia.com/terms/n/needsapproach.asp
– Consumer Financial Protection Bureau, “Buying life insurance.” https://www.consumerfinance.gov/consumer-tools/insurance/life-insurance/
– National Association of Insurance Commissioners (NAIC), Consumer Information on Life Insurance. https://content.naic.org/consumer_life_insurance.htm
If you’d like, I can build a personalized needs‑approach worksheet for you (you provide income, debts, assets, dependents and time horizons) and calculate a recommended coverage amount step‑by‑step.