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Life Insurance — How much and what kind

There are two ways to answer this question: the SHORT way and the LONG way. Part of the difference depends upon what the life insurance is supposed to do for your beneficiary. If the purpose is income replacement, the right amount of insurance may be different from the amount necessary to buy out your business partner or to pay off the mortgage on your office building.

Accordingly, here are some short answers along with brief explanations.

15 – 20 x Income Rule

Most life insurance purchased by physicians with families is for income replacement, one way or another. In that context, depending on size of family, debt load and family objectives such as paying for a child’s college education or needing to care for an elderly parent, usually about 15-20 x the household annual income is sufficient.

It works like this. Let’s say the breadwinner has a salary of $150,000 per year, upon which her family depends. If s/he dies, her income stops and probably needs to be replaced in whole or in part. At 20 x Income, she would have been protected with $3,000,000 of life insurance, which – if invested conservatively for the long term – might produce a return of, say, 5%. Five percent of $3,000,000 is $150,000 – exactly duplicating her salary. Of course, if the return were 4%, the income stream would be $120,000 per year, about 80% of what she produced while alive. And, while this won’t replace your life partner or a child’s parent, it will go a long way toward keeping the family living in its own world – the world the deceased helped them get used to.

So, the simple rule is: if you don’t have time to sit and figure this out, own 15-20 x your annual income in life insurance protection – lean toward the lower amount if you have fewer debts and fewer dependents; lean toward the larger figure or more if you have high debts and/or more dependents.


This is not the venue for an in-depth discussion of the merits of preserving and providing a dynastic legacy for one’s family after death. However, as a financial advisor, it is difficult to feel comfortable designing a family’s survivor income plan, or a retirement income plan, in which the income might expire before the need for it does.

If you are concerned about this, here is a simple solution.

Most scenarios of long-term investment strategies demonstrate that – for the long term – a beneficiary (your family at your death; you after a disability or in retirement) can withdraw and spend an after-tax, inflation adjusted income of about 3% of the capital amount. In other words, $3,000,000 properly invested for the long-term will probably allow the income beneficiary to withdraw about $90,000 (3%) – inflation adjusted and after income taxes – for the rest of his or her life. This will also preserve the principal intact for children or charity at the income beneficiaries’ later death.

For example:

Invested capital $3,000,000
Assumed Long-Term Investment Return 8%
Income [$3,000,000 @ 8%] $240,000
Minus Income taxes @ 25% assumed rate ($60,000)
After-tax income [$240,000 minus $60,000] $180,000
Amount reinvested in the principal account to offset inflation of 3% $90,000 [3% of $3,000,000]
SPENDABLE INCOME [after inflation and taxes] $90,000 about 3% of capital


This formula of spending no more than 3% of the investment amount per year may well:

  • cover all the income taxes
  • grow the annual income at the rate of inflation
  • grow the invested capital account at the rate of inflation
  • preserve a legacy for the future of children or charity

Posted on Thursday, January 5th, 2012 at 2:46 pm under Resources.