If you’ve ever been in the market for life insurance, somebody probably recommended to you that you buy a policy equal to seven times your annual salary. This is an old adage bandied about by the insurance industry to – you guessed it – sell more insurance. Let me tell you why this is flawed. Life insurance is designed to be income replacement. It’s designed to pay the bills when you’re no longer around to bring home the bacon. So the correct amount of life insurance factors in the expenses that need covered, the amount of time those expenses need covered less any existing assets that can be used.
Take a two income couple with kids in high school and college. Their insurance needs are much more finite than say the sole bread winner with a new born. Who needs more life insurance? Here’s a hint: It’s not a function of salary. Further, it fails to take into account the possibility of Social Security survivor benefits for your spouse and/or guardian of your children. This is routinely neglected when considering how the bills get paid in your absence. But it greatly reduces the amount of coverage that’ll you need.
Don’t buy life insurance by multiplying seven or any other number by your salary. Instead, look at the expenses that need covered and the amount of time they need covered plus things like college and wedding funds. Subtract out what could be covered by your existing financial assets and Social Security survivor benefits. The total you come up with is likely much different than just blindly using a multiple of your salary.