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Some tips on tailoring life insurance so it's neither over nor under

What if you went to a grocery store for a gallon of milk? Instead of buying a gallon jug or two half-gallon cartons, you walk out with eight half-pint bottles. That's how a lot of people buy life insurance, says John Sestina, a financial planner in Columbus, Ohio. When they buy a house, their lender sells them mortgage insurance. When they buy a car, the dealer sells them a policy to cover the car loan. All this is on top of any whole-life, term, or group-life policies they may have.

With both the milk and the insurance, Mr. Sestina says, you spend more money to get what you need and end up with less convenience.

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At a time when consumers are faced with a stupefying variety of life insurance choices, including universal life, variable life, single-premium whole life, and hybrids of each, it's sometimes easy to forget what life insurance is for and not to know how much insurance you need.

``A lot of people are underinsured, but just as many people are overinsured,'' says Steven Enright, a planner with Seidman Financial Services in New York. Overinsurance often comes from buying all those separate little policies, while underinsurance usually happens because people don't keep up to date with their financial situations and make adjustments to their insurance coverage.

``You have to review your insurance needs every few years,'' Mr. Enright says. ``Don't assume that if you do an insurance analysis today you'll have the same needs in five years.''

Meeting those needs is the most important reason for life insurance: to provide a continuing source of income for dependents. The insurance settlement itself is not the income; its purpose is to generate enough income on its own to replace any lost earnings of the person being insured.

There are several ways to figure out how much insurance you need for this. The one often used by the insurance industry and its sales force is simply to take a multiple of earnings. Depending on your age, family size, income, and plans for your children - like college - this theory says your insurance coverage should be anywhere from three to eight times annual earnings. So if your present income is $50,000 and you want coverage equal to five times earnings, you would buy $250,000 worth of insurance.

But there are too many variables to make this an effective formula in very many cases. A married, two-earner couple with no children does not need as much insurance as a father with three young children and a wife at home. A single working woman needs very little insurance - perhaps enough to cover taxes and funeral expenses and to pay off any debts - while a woman raising children on her own needs plenty of insurance.

A more accurate, though not perfect, formula is a ``capital-needs analysis.'' It's more complicated, to be sure, but it's also more likely to keep you from buying too much or too little insurance.

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``I really don't like any formulas,'' says Peter Weston, a financial planner in Birmingham, Ala. ``But in the absence of a complete financial plan, [a capital-needs analysis] is not a bad fallback position.''

Even when a number for insurance coverage is pinned down, Mr. Weston says, you have to look at other factors. What kind of job, if any, might the surviving spouse get? What future, like college or graduate school, is planned for the children, and how close are they to college now? Are there any investments or other assets that could either be spent or converted to income producers? What about grandparents; do they depend on the insured for their continued comfort? On the other hand, do the grandparents have any resources they could use to help out if the main breadwinner passed on?

Leaving those questions aside for the moment, a capital-needs analysis works like this: How much yearly income does a family need to live on and how much does the person you want to insure contribute to filling this need?

Let's assume the salary of the breadwinner (husband or wife) covers all of this need. Start by looking at how much this person brings home and subtracting the costs that would no longer be incurred - like food and clothing - after that person is gone. Most planners put this at about 15 or 20 percent.

So, figuring on current take-home pay of $30,000 and taking away 15 percent, the surviving family members will need $25,500. If there are children, social security will cover some of this until they are 18. A social security office can tell you how much you qualify for, but let's figure on receiving $5,000 per child a year. With two children, that's $10,000. Our income need is now $15,500 a year.

Some of this may be covered by money from an employer-sponsored savings plan, like a 401(k), an individual retirement account, or group life insurance from the employer, often adding up to two or three times salary.

Let's say our breadwinner's group insurance would be just about enough to pay off the mortgage, which costs the family $600 a month, or $7,200 a year. With that paid off, the income need is now $8,300 a year. To build in a comfort level, we'll boost that to $10,000.

The question now is how much insurance is needed to spin off $10,000 a year at a moderate interest rate of, say, 8 percent. To find out, divide $10,000 by 8 and multiply that answer by 100. The final figure is $125,000. If you want to do something extra, like cover college expenses, you could hike that to $200,000. Term policies are often sold in multiples of $50,000 to $100,000.

Depending on the insurance company, your age, sex, and whether or not you smoke, you can buy $100,000 of term insurance for as little as $160 to $250 in first-year premiums. If you buy more than $200,000 or $250,000 of coverage, the relative cost drops dramatically. That is, while $100,000 may cost $200, you might get $250,000 worth for $300.

Probably the fastest way to find the best coverage at the cheapest rate is to call a few independent life insurance agents. They can choose among several companies to make sure you get enough insurance without loading you up with a bigger insurance bill than you can afford.

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