How Much Life Insurance Do You Really Need?


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When my wife and I first had children, one of the big questions I asked was a familiar one: How much life insurance do I need? While nobody likes to think of their own demise, it’s prudent to consider what financial ramifications your death could have on those you leave behind.

It gives me tremendous peace of mind to know that if I die, my wife will have enough to pay off all our debts and take care of our family. While it’s hard to dispute the sensibility of life insurance in general, many people disagree on how large of a life insurance policy you should have. So, here are some things to consider when you ask how much life insurance you should buy.

1. Rules of Thumb

When it comes to buying life insurance, there are some basic guidelines to help you determine how much you need. While no rule of thumb should be followed blindly, they can represent a good starting point for further analysis. Here are several widely-used rules of thumb when it comes to buying life insurance:
  • 17 times salary: To calculate your suggested policy amount, simply take your annual salary and multiply it by 17. This approach is pretty easy: if you make $75,000 a year, you’d buy $1,275,000 in life insurance. With this amount of coverage, your beneficiary should be able to replace your income with interest and dividends earned from investing the life insurance proceeds. In effect, the 17 times salary rule of thumb is an “income replacement for life” model.
  • Sliding Scale: Some suggest refining the multiplier above, based on your age. The younger you are, the higher the multiplier. For example, a 20-something would multiply their annual salary by 20, while somebody nearing retirement would multiply their income by just 5. This also aims to replace your income for life, but it assumes that if you’re young, your income will increase before your insurance term is up. It also assumes that those entering retirement need less because they should have retirement savings and assets, and are probably close to paying off things like their mortgage.
  • 5 to 10 times salary: If you are not looking to replace your salary for life, many suggest just getting 5 to 10 times your current salary in insurance. The idea with this rule of thumb is to help your loved ones pay off debt and to have some time to grieve without the added stress of financial worry. However, it won’t replace anywhere near your full income for their lifetimes.

2. What Can You Afford?

Regardless of how much coverage you need, think you need, or someone says you need, a critical financial consideration is how much life insurance you can afford. Exceeding a balanced budget isn’t in keeping with sound financial planning, no matter the line item. Admittedly, adjusting your spending in other areas to increase the premium you can afford may be prudent.
Besides budget considerations, it’s important to consider that missing payments can result in the termination of your policy. Then, you deal with having no life insurance at all, and possibly having to take out a new policy with a higher premium when you’re older. It’s better to opt for a smaller, more affordable policy than to risk losing coverage altogether when you fall on hard times.
Bottom line: don’t ask your family to live like paupers now so that, in the eventuality of your death, they can live like kings.
Make this your first order of business. This will help you to explore your maximum coverage without being stressed or tempted to buy more than you can afford. Find your maximum monthly payment, and stick to it as you seek quotes.

3. What Is Your Minimum Coverage?

None of us would mind making our family comfortable for the rest of their days. But before we tally up a $10,000 payoff for every second cousin, let’s consider the bare minimums needed. Typically, the most important factor people consider is liabilities.
Is there a car payment? A home mortgage? A serious desire to provide for your child’s college education? Evaluate what debts and costs your family will have to face without you. Also consider funeral and possible end-of-life expenses.
Add up these costs, and you’ll get the minimum coverage you need. (Can’t afford the premiums even on that smaller amount? Get as close as you can, and increase your coverage as soon as you’re able.)
Resource: Why Even Singles With No Children May Need Life Insurance

4. What Do You Want to Accomplish?

The bulk of your baseline coverage should be dictated by the minimum coverage requirements you just tallied. However, there are those who do want a considerable amount more than what will meet their family’s financial obligations.
Many people evaluate what it would take to enable their grieving spouse to mourn for a year or two before returning to work. Others want to replace their income for life, so that a spouse never has to return to work. This consideration may be even more important if your spouse is a stay-at-home parent, and you don’t want that situation to change of necessity.
Again, this depends almost completely on your individual lifestyle. So, give thought to what you’ll want the money to cover, over and above paying off your debt.

5. What About Non-Working Spouses?

Many of the calculations we’ve covered assume that you’re currently bringing in an income. But what if you’re a non-working spouse? Do you still need life insurance?
It depends. If you don’t have children at home, you may not need life insurance on yourself. Your spouse’s expenses may not increase significantly if you were to pass away.
But if you’re a stay-at-home parent, you’re providing significant services for the greater good of the family… for free. In this case, you need to add up what it would cost to replace the essential services you provide. At a minimum, your spouse would have to cover childcare. If your spouse works full-time and would be raising the children as a single parent, should you pass away, you might want to factor in additional services like regular house cleaning, grocery delivery, and more.
Again, you can decide whether you want to cover these services until your children are adults, or just for a year or two after your untimely demise.

6. Rules of Thumb Revisited

As described above, most rules of thumb for life insurance involve multiples of your salary. If you’re looking for minimum coverage, I’d say stick with the tally of your basic liabilities and goals. This will be more realistic and likely more affordable than blindly following a rule of thumb. If room clears in your budget later for a more expensive policy, you can always add a second policy or increase your current coverage amount.
However, if you are looking for your family to continue receiving the equivalent of your monthly paycheck for X number of years, then a multiple of your salary is a good approach to choosing the amount of life insurance to buy.

7. Don’t Forget About Terms!

I’ve made the assumption that your search for life insurance will likely bring you to the conclusion that term life insurance will meet your needs. To get a sense for the differences in life insurance (term, whole, permanent), check out our article discussing permanent life insurance.
At the same time you’re deciding on how many dollars of coverage you’ll need, you’ll also be faced with the question of how many years you’ll need the coverage. Ultimately, most financial gurus advocate self-insuring during the latter half of your life. Self-insuring simply means that you have enough money and assets to achieve the same financial goals you have identified above.
If you’re debt-free, or at least largely debt-free, and your children are grown, you may not need a large life insurance policy any more. Since life insurance is cheaper to get when you’re young, consider taking out a sufficient policy as soon as you’re married or have your first child, and choose a term that should last until your last child flies the nest.

8. Do You Need a Professional?

Life insurance can, and should, be part of a larger estate plan for the wealthy, who will need to worry about things like inheritance taxes upon their deaths. But if you don’t need this type of estate planning, you can most likely make a wise life insurance policy choice on your own.
Comprehensive financial planning can be helpful in some cases, especially if you can get a financial plan without paying a huge fee. With that said, choosing the correct life insurance term and amount isn’t rocket science if you walk through these steps.
Don’t put off getting a life insurance policy just because you aren’t ready for financial planning services. Get at least enough to cover your basic needs. You can always ask for advice later if you decide you might want to increase your policy, or if you wind up in a trickier situation such as figuring out how to provide for a child with disabilities.
If you’re still not sure what level of life insurance you really need, consider checking out Policygenius, a life insurance aggregator, that helps folks find the best policies, compare offers, and understand terms.
Summary:
  • In the event of calamity, having some life insurance is better than having none. Don’t put off the decision.
  • You can always layer coverage using multiple policies, meaning if you didn’t buy enough coverage the first time, you can get additional coverage through another policy.
  • People joke that you want to have enough coverage to make your spouse comfortable, but not enough to make them too comfortable with the idea of living without you. There might be something to that.
  • Perks and rewards are obviously secondary to premium amounts and coverage, but different insurers offer different benefits and features. Check to see if you receive any premium back at the end of your term, additional accidental death payouts, and terminal illness payouts.
  • Unless you have a particularly complex life situation, you can probably choose a good life insurance policy on your own.
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