How Much Life Insurance Do You Need?
Getting life insurance is a great way to secure your family’s future should you unexpectedly die early.
While purchasing a life insurance policy isn’t difficult, figuring out what to buy can be.
One question often pops up when people are buying life insurance.
That question is:
"How much life insurance do I need?"
The answer will vary based on every person’s specific situation.
Even so, some guidelines can help you arrive at a reasonable estimate for your needs.
Here’s what you should know.
Life Insurance Rules of Thumb
Experts have a few rules of thumb that can help you get started figuring out how much life insurance you need.
The most detailed rule of thumb takes a little effort to calculate how much life insurance you may need.
It provides a more accurate estimate.
To determine the amount, you look at the following categories:
Then, add up the need for each category to get the amount of coverage you may want to purchase.
Start by looking at any debt and other financial obligations your family would have to pay off if you die.
This includes things like credit cards, personal loans, student loans, car loans, and more.
Paying off these debts helps your family lower expenses which can be very helpful in a stressful time.
Next, consider how much income you want your family to have after you die.
If you’re the breadwinner, they’ll need to replace your income either permanently or until your spouse can find a job that pays enough to support the family.
Consider the number of years of income replacement you want to provide.
Also, consider how long your family may go without an income as they grieve.
Based on this, you may decide your family needs five years of income or enough income until your kids leave home.
While your mortgage is debt, most people consider this a significant debt.
Don’t include this amount both in the debt and mortgage sections. Only include it once.
Paying off the mortgage will significantly reduce your family’s monthly expenses.
This makes it easier to get by if your spouse can’t completely replace your income.
Finally, consider including education costs.
This can be for private school for your kids in grades K-12. It should also include college costs.
It may include childcare costs if your kids aren’t in school yet.
Multiple of Your Salary
A much easier rule of thumb to determine your life insurance needs is a multiple of your salary.
Depending on the financial expert you ask, you may hear different salary multiples as recommendations.
Some experts quote as little as five years of income. Others quote as much as 15 years.
The majority of experts fall in the 10 to 15-year range, though.
Salary Multiple Plus College
If you want to take things a step further than the salary-multiple method, you can add extra costs.
One common extra cost to add is college costs for each child.
College is outrageously expensive, so doing so can provide some stability for your family.
A general rule of thumb for college costs is to add $100,000 per kid. Unfortunately, that may not be enough.
Take a look at estimated college costs based on your child’s age. Then choose the number that makes sense to you.
Remember, college costs often rise faster than inflation.
Don’t Rely on Rules of Thumb Alone
Relying on a rule of thumb isn’t great advice when you’re considering something as important as life insurance.
Rules of thumb give you a starting place. They allow you to start figuring out what to think about.
Nothing replaces making a conscious decision of how much life insurance you need.
Here are a few things you can do to help that process.
Decide why you’re buying life insurance
The first thing you should do is figure out why you’re buying life insurance.
- Are you buying to replace your income for a couple of years?
- Do you want your family never to have to work after you die?
- Or do you want to insure your stay-at-home spouse to cover daycare costs until kids reach school age?
Some people only want to cover their final expenses with life insurance.
Others may have a goal of paying off debt because their spouse has a stable career.
These are all very different goals with very different life insurance needs.
Of course, you can combine several of these goals. You aren’t limited to just one.
Once you know what you want life insurance to cover, it’s time to take the next step.
Figure out your needs
After you know your goals, figuring out your needs is a bit easier.
Take a look at each goal and figure out how much money you would need to meet that goal.
If you want to replace 10 years of your salary, multiply your salary by 10.
If you want your family never to work again, you might want to use another metric.
It’s commonly referenced that you’ll need 25 times your annual expenses to become financially independent. Even so, some people prefer a safer number of 33 times your costs.
People that simply want to pay off debt need to add up their debt balances. This assumes no more debt is taken out, though.
Know your needs may change
Your needs today may change in the future. Consider any future life changes your family may go through.
A newlywed couple may not yet have kids but plans to have kids. This significantly increases future expenses.
You may have a decent job now, but a big promotion may increase your salary drastically.
If you adjust your lifestyle to increase with your new salary, your old life insurance calculations won’t work anymore.
You can deal with these issues in one of two ways.
First, you can purchase more life insurance than you need while you’re young.
Young, healthy people have the lowest life insurance cost they’ll likely ever have access to.
You can even submit to a medical exam that may lower your costs even further.
The alternative requires you to buy more life insurance later in life when you need it.
This may be possible if you’re still healthy and young enough.
People that get diagnosed with severe diseases may have trouble purchasing more life insurance later.
Even if they can get insurance, it may be prohibitively expensive.
Life insurance table ratings
|Table Rating||Premium Increase Over Standard Classification|
|1 (or A)||25%|
|2 (or B)||50%|
|3 (or C)||75%|
|4 (or D)||100%|
|5 (or E)||125%|
|6 (or F)||150%|
|7 (or G)||175|
|8 (or H)||200%|
|9 (or I)||225%|
|10 (or J)||250%|
Don’t forget to account for inflation
One sneaky financial concept often surprises people when it comes to life insurance death benefit payouts.
People often feel the money doesn’t go as far as they thought it would.
There’s a good reason for this.
Many term life insurance policies last 20 or 30 years.
If you die toward the end of that policy term, inflation has slowly been eating away at the policy’s value.
Let’s say you buy a $500,000 30-year term life insurance policy today.
In 29 years, that policy will be worth $212,173 in today’s dollars if inflation is only 3% per year.
That’s less than half of the life insurance you thought you were getting.
Make sure to consider the impact of inflation when purchasing a policy.
Consider using a calculator
When you start juggling several goals, it often makes sense to use calculators to aid the process.
Detailed life insurance needs calculators can help you figure out how much insurance you may need.
Be aware that many companies that provide these calculators also sell life insurance. They may make it seem like you need more insurance than you do.
Understand how the calculator works before making purchasing decisions based on the results.
Consult a Fee-Only Fiduciary Financial Advisor
While calculators can help, they aren’t perfect.
Sometimes, you need someone to help you figure out your family’s specific life insurance needs.
Life insurance brokers can be biased
A life insurance salesperson could help by giving you several life insurance quotes. After all, they sell life insurance for a living.
Unfortunately, they get paid commissions to do so. Those commissions could, and likely do, impact the policies they suggest.
For instance, most people are best off with term life insurance. However, permanent life insurance pays huge commissions.
This may cause your life insurance salesperson to recommend or convince you to purchase a whole life insurance policy instead of a term life insurance policy.
Unbiased financial advisors
The good news is there is a particular type of financial advisor that can provide truly unbiased advice.
Fiduciary means the advisor must act in your best interests for your finances. They can’t suggest something that’s just suitable and not ideal.
Fee-only means that you have to pay them for their time. You can often pay a flat or hourly fee for a consultation.
When you’re the one paying the advisor, you know they’re working for you.
They won’t sell you a policy they would get commission on, but they can recommend a policy to get.
Getting life insurance coverage can be complex. If you want to make sure you’ve thought of everything, paying a fee-only fiduciary financial advisor may be worth the cost.