There are several life insurance needs estimators available. These contain various calculation processes that reveal the coverage amount that you need. Good life insurance needs estimators will take into account the following:

i) Future economic value
ii) Immediate cash needs
iii) First year shortfall
iv) Income Replacement Fund
v) Available coverage

i) Life insurance is primarily income protection, even though it may fulfil other functions. Your economic value is based on your past income, current income and projected earnings. By definition, the Future Economic Value (F.E.V.) consists of your projected income primarily. This is calculated by determining the number of years of employment that you have remaining, then applying the formula for the sum of all terms in a geometric progression. This formula uses a salary increment and is based on current income. The average of your projected earnings would then yield the income figure that you should protect for your beneficiaries.

ii) Immediate cash needs are those needs that are payable immediately on your death. They include all final expenses, outstanding loans and mortgages, legal and executor fees, education funds and charities. Funeral expenses are clearly not the sole consideration where life insurance is concerned. All debts and expenses that need to be paid shortly after your death would be considered as immediate cash needs.

iii) The first year shortfall is based on the principle of replacement income. It is calculated as follows:
a)Establish a value for the household income
b)Set a target percentage of the household income that your beneficiaries can survive on.
c)Express the target percentage as a dollar value
d)Subtract your own income from (c)

Since it would take about one year for money received from an insurance settlement to be able to fully replace the shortfall in income from your departure, the first year shortfall would bridge that gap.

iv) The Income Replacement Fund (IRF) is based on the principle of money at work. It is designed to provide your beneficiaries with the value of the first year shortfall in subsequent years. To evaluate the IRF, you need to divide the first year shortfall by an achievable rate of interest. For example if the first-year shortfall is $50,000.00, then at an effective interest rate of 10% per annum, the IRF would be $500,000.00.

v) Available coverage consists of existing life insurance policies, savings and investment accounts. A proper life insurance calculation process must include what you have in place already. This accumulated figure is then subtracted from the coverage needed to give an idea of the shortfall.

Life insurance needs are estimated by subtracting the coverage available from the coverage need. The coverage needed is determined by the adding the IRF, first year shortfall and immediate cash needs. The calculation may reveal that no further coverage is necessary. Doing this calculation using a spouse's or partner's income may make it seem as though a non-working spouse does not need insurance at all. This would also occur when one spouse is earning the lion's share of income. In such cases, the individual should calculate the insurance need without reference to household income or the income of the other spouse.

Learn more about this author, Darrell Victor - Insurance Subchannel Steward.
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