In a nutshell, life insurance is a contract agreement between you and an insurance company. You agree to pay a premium for the coverage amount you select. In exchange, the insurer pays out a lump sum, called a death benefit, to your designated beneficiaries upon your death. Your loved ones can use the money any way they choose. However, a death benefit is commonly used to pay for funeral costs, settle debts, and act as a replacement income source.
You already understand how important it is to make life insurance part of your long-term financial plan; it’s a good way to provide for your loved ones even after you are gone. The question is—how much life insurance do you need? Let’s take a closer look.
Determine What Type of Life Insurance You Should Purchase
Before you start calculating a figure, it’s essential that you understand the different types of life insurance—term and whole life insurance.
Both term and whole life insurance have their advantages. Take into consideration the reasons behind your decision to purchase a policy to help you determine which is best.
Term Life Insurance
Term life insurance lasts for an agreed-upon time period, usually between 10 and 30 years. Many people choose this type to cover their income and provide security until their mortgage is paid in full or their children complete college. It’s easier to calculate your insurance needs for term life if you take out the policy for these reasons.
Whole Life Insurance
As the name suggests, whole life insurance provides coverage for your entire life. This type of policy requires a bit more intentionality when choosing a coverage amount because you’ll need to include additional expenses, like burial costs, income replacement, and support for your family. Some things to consider are your future plans and if you are likely to buy a home or expand your family. This affects your total insurance needs.
How To Calculate Your Life Insurance Needs
You can estimate the amount of life insurance you need to purchase by calculating your financial obligations and subtracting your assets. Tally up all your ongoing costs and debts, such as your mortgage, college loans, and credit card debt. Then, deduct your assets, like savings and retirement funds. What you’re left with will be the minimum amount of life insurance you need.
If you have a family and are the primary income earner, you may want to increase your coverage to an amount that replaces your current salary. After the debts are paid off, the rest of the money can be used to support your family financially for years to come.
Remember that stay-at-home parents need life insurance too. They provide a quantifiable value to the household the same way as any other contributing member. It’s tough to put a figure on the coverage required, but you can start by adding up the costs of the services they provide, such as childcare, meal preparation, household chores and home maintenance.
There are plenty of recommendations to follow that will help you come up with an estimate for the amount of life insurance you need.
Income Multiplied by 10
One of the most common ways to nail down a number is to multiply your current annual income by ten. However, show caution when using this method. It tends to oversimplify the figures, and you’ll still need to take into account your debts and assets.
10 Times Income Plus College Expenses
Expand the previous method by adding an extra $100,000 per child to pay for future education needs. You can adjust the figure as needed to better reflect your children’s college plans. While this option provides a bit more futuristic thinking, you will still need to mindfully add in your debts and assets to ensure you don’t oversimplify the number.
The DIME method typically gives you the best estimate of your life insurance needs, as it looks more closely at your financial breakdown. Some things the DIME method will take into consideration:
- Debt: This includes all consumer, medical and school debt plus your estimated funeral costs.
- Income: Multiply your yearly income by the number of years you believe your family needs support.
- Mortgage: The full amount necessary to pay off your mortgage.
- Education: The total cost of putting all your children through their remaining school years and college.
While these are the most common major expenses that most people need to account for as part of a long-term financial plan, it’s always best to tailor your calculations to your own situation and account for all your financial needs and personal goals.
Try a Life Insurance Calculator for a Quick Estimate
You can also plug your financial details and personal information into a convenient online life insurance calculator to get a good estimate of your needs. This is also a great way to double-check the figure you calculated by hand.
Tips For Finding The Right Coverage
Here are some tips to ensure you get the right amount of coverage for your family.
Overestimate Your Needs
When it comes to life insurance, it’s best to purchase more than you think you’ll need. You may accumulate additional expenses and debts or have other extenuating circumstances that increase your insurance needs. It’s always better to add a cushion to account for any unexpected changes that arise after you purchase your policy. And don’t forget, any unused additional income will be used to help your loved ones maintain their lifestyle, so there really isn’t a downside to overestimating.
Discuss Your Life Insurance Plans With Your Family
Talk numbers with your partner and close family members. They can point out any details you may have missed and help you reach a figure that makes sense. Ask how much money they believe is needed if your income is gone and if they would work part or full-time. Go over all the possible scenarios together.
Purchase Multiple Policies
It’s normal for your life insurance needs to change with time. Instead of worrying about it, consider purchasing multiple policies in smaller amounts for greater flexibility and control as your life evolves. This also gives you more freedom to shop around for favorable policy terms, like low premiums.
Benefits of Life Insurance
Many people buy life insurance to cover their final expenses. It’s a smart decision to pay for burial costs and settle any outstanding debts you have so they don’t become a burden to your family. Life insurance can also replace your lost income and provide for your family with monthly provisions or an inheritance to help them later in life. Whatever your reasoning, life insurance is an essential coverage that you need to consider.
You might also be interested in: Everything You Need to Know About Term Life Insurance