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How to calculate the amount of disability insurance you need

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Long-term disability insurance, as we've discussed here before, is essential to keeping up with your financial responsibilities if you are unable to work for an extended period. Without a source of money to replace your income, the trauma of an injury or illness can be compounded by financial chaos.

Determining how much insurance you need should not be a guessing game. You need to do a bit of homework. You want to calculate the minimum amount of benefits you'll need to keep up with your living expenses while you are unable to work. The formula is rather simple. Calculate your monthly living expenses. Then subtract sources of income besides wages. Next, subtract the amount of money you won't be spending if you are not working. That will give you the minimum amount of benefits you'll need on a monthly basis.

Calculating your monthly living expenses should be fairly simple. You should be doing it anyway. If you aren't, this is a good time to start. Most expenses like mortgage payments, rent and utilities are monthly. Look at your checking account and credit card activity if you need to jog your memory. Don't forget annual, quarterly and bi-monthly expenses. Just divide accordingly to get a monthly average. Also factor in some money for unexpected expenses such as the washing machine or the transmission in your car giving out.

Next, subtract all sources of income that will still be coming in if you aren't getting a paycheck. This could include interest, rental income, alimony, other types of disability income and your spouse or partner's income. If he or she is able to pick up extra income if you're unable to work, factor that in.

Finally, subtract the things you won't be spending money on if you aren't working. Commuting costs will likely be a significant one. If you usually go out to lunch or take a trip to Starbucks every day at work, you can subtract those expenses as well. You may find that those daily food and beverage expenses add up to a nice chunk of change.

Just as important as making sure you have enough insurance is finding a reputable insurer. Having insurance does little good if you have to fight to get the money owed you when you make a claim.

Source: The Motley Fool, "How Much Disability Insurance Do You Need?" Sally Herigstad, May. 18, 2014

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