How much life insurance does a doctor need?
There are many theories around when it comes to how much life insurance you need.
Some people pick a number out of thin air, some go with a multiple of their annual income and some choose a figure based on how much they’re willing to spend on premiums.
But with so much at stake, it’s important for a doctor or any other high income earner to get their life insurance amount right.
To start with we’ll take a look at some of the different methods of calculating your life insurance amount, and we’ll then look at what we believe is the most appropriate method.
A nice round number
The first method we’ll look at is the most simplistic, and potentially most dangerous method.
If you’ve seen the many life insurance ads that appear on television today you could be forgiven for thinking that choosing a life insurance amount is incredibly simple.
You just choose a nice round figure of say $200,000 and everything will be fine. Of course this couldn’t be further from the truth.
As a doctor you might think that going with a big round number of $1,000,000 would be the way to go, but even an amount such as this could be inadequate depending on your own situation.
Cover the mortgage
Another simple method for calculating your life insurance needs is to choose an amount which is sufficient to cover your mortgage.
Repaying your mortgage in the event of your death is a great thing to do for your family, but there are major question marks over whether this will be sufficient.
Let’s say you have a mortgage of $700,000 on the family home, and at this relatively early stage of your career as a doctor you don’t have any additional investments other than your superannuation.
If you had a $700,000 life insurance policy you could pay out the mortgage, but what will happen to your partner’s and your children’s lifestyle now that you’re gone?
They might have a nice house to live in, but unless your partner has the ability to return to work in a high income earning position, any hope you had for private schooling and your family’s lifestyle will be gone.
Any superannuation you have accumulated will help of course, but depending on how far into your career you were at the time of your death, it might not last your family too long.
For these reasons and more, taking out an amount of life insurance only sufficient to cover your mortgage will rarely be good enough.
A multiple of your annual income
This has been a very popular method for many years, and simply involves taking your annual salary and multiplying it by a number of years.
The number can vary however, with some people saying you should have life insurance equal to two year’s salary, some saying five years and some saying ten years.
With so many variables, can this really be a good way for a doctor to calculate their life insurance amount? Probably not in our opinion.
Let’s say you are a GP earning $200,000 per year. We’ll go with the option of insuring five years’ worth of salary.
In this case you’d have $1 million in life insurance. This sounds like a good number, but how do you know whether or not it’s right for you and your family’s needs?
The fact is that without knowing about the size of your mortgage, the number of children you have and their ages, and the goals you have for your family, there is no way to know if $1 million is sufficient.
How much are you willing to spend?
The final method we’ll look at (before running through our own preferred method) is one that is based on your budget rather than your needs.
In this scenario a doctor sets a budget for their monthly insurance premiums, let’s say $300 a month for example, and simply takes out whatever level of cover that will get them.
This method is more common than you might think, and generally happens something like this:
A doctor meets with a financial adviser who tells them they should have $1.8 million life insurance, which will cost $360 per month. The doctor then says they’re only willing to spend $300 per month, so the amount of cover is reduced to $1.2 million.
Please note that these figures are only examples and do not reflect an actual policy or quote.
There is nothing inherently wrong with this method, provided that your budget isn’t too much lower than the cost of the recommended amount of cover.
It’s just important to remember that the amount of cover you will end up with will be less than you might actually require to meet the goals that you did have for your family.
Our preferred method
And now we move onto our preferred method, and the one that is used by most good financial advisers and financial planners.
This method is based entirely on the needs and objectives of the client, and therefore the actual amount of life insurance will be different for each individual.
To start with the amount should be sufficient to clear all debts and liabilities.
Debts that are held against investments will be assessed individually. For example some people will be happy for a mortgage on an investment property to remain in place as it is being covered by the rent.
On the other hand some people will prefer that the debt is repaid in full, which will mean more rental income will be staying with his or her family.
The next thing to look at is the doctor’s financial goals for their family. If they want their children to receive private schooling and have funds available for university, then the life insurance amount needs to include provisions for this.
Many doctors will also choose to include a cash buffer for the family. This may be sufficient to replace their income for a year after their death, or even five or ten years depending on their wishes.
At the extreme end of the scale, some doctors will choose to include a significant lump sum amount that can be invested in order to provide an ongoing income to their family for the rest of their lives.
As you can see, when using this method the amount of life insurance required could really be anything depending on what the person wishes to happen in the event of their death.
You could potentially calculate these figures on your own, however a good financial adviser will be able to work through all of the figures with you in order to put together a specific figure.
Whatever amount of cover you end up with, the most important thing is that the amount is sufficient to meet all of the goals and aspirations that you have for your family.