How much life insurance do I need?
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Life insurance may be a valuable financial tool for many individuals, but choosing the appropriate amount of coverage for your needs might be challenging. There are many important factors you could consider, like your current income and assets, the number of financial dependents you have and your family’s lifestyle. Before choosing life insurance coverage limits, Bankrate explores a few things you may want to keep in mind. You may also wish to consult with a licensed insurance agent or certified financial planner before purchasing a policy to ensure that you are purchasing a policy that meets your financial goals.
What is life insurance?
Life insurance provides a financial payout to one or more beneficiaries of your choosing in the event of your death as long as you pay the premiums, and the terms of the policy are met. Depending on the type of policy, life insurance will cover end-of-life expenses — such as a funeral or outstanding debts — or will provide compensation to sustain dependents’ quality of life or future financial needs.
Who needs life insurance?
There are many types of people in varying stages of life that may benefit from life insurance. If you have dependents who rely on you financially, such as a spouse, kids, an elderly parent or a disabled sibling, you might be a good candidate for some form of life insurance coverage. Even if you do not have any financial dependents at this time, life insurance could help you pay for your end-of-life arrangements or leave money to a charitable organization. Additionally, buying a policy while you are still young and healthy may help you lock in a lower rate.
How much life insurance do I need?
Deciding how much life insurance you need depends on several personal factors. These may include:
- Your age
- The ages of your spouse and children
- Your income
- Your mortgage and other debts
- Future major expenses for your children and/or spouse
- Burial costs and other final expenses
When deciding how much life insurance to get, many insurance professionals recommend considering what your goals are for your life insurance. For example, if you want your life insurance to provide for your spouse and dependents after your death, you will probably need more coverage than someone who just needs their life insurance policy to cover their burial and funeral expenses.
Calculating your life insurance needs
There are several strategies you could use to figure out how much life insurance you should purchase. You might choose to speak with a certified financial planner who can assess your financial situation and make a recommendation based on your family’s potential needs. You can also use a free life insurance calculator to give you a general idea of how much coverage may be necessary for you.
Another option is to use one of the popular models devised by insurance companies and financial experts. Here are three common approaches that might help you pick a life insurance coverage limit:
1. The DIME Formula (and 10 Rule)
The old “how much life insurance do I need” rule of thumb was to take your income and multiply it by 10. This was the industry’s standard for many years. However, this fails to account for several things.
Most notably, it does not take into account your family’s living expenses. This could vary wildly if you have one child or four. Moreover, it does not account for single-income families.
As grim as it sounds, it’s important to ask yourself what would happen if you and your partner both die and only one has coverage? The 10 Rule left many questions unanswered. In its place came the Dime Formula, which takes into account the following:
- Debt and final expenses: Come up with a solid number based on all the debts you owe, and include the costs of final expenses for each parent.
- Income: For income, a good rule of thumb may be to think about how many years your family would need income for in your absence. Multiply the number of years by your annual income.
- Mortgage: Include the total amount owed on your mortgage and the property taxes assessed. Similar to income, think about how many years your family would need the money to cover property taxes, then multiply your annual tax total by those years.
- Education: Determine the total cost of educating each of your children through their remaining years of school, including college.
Once you come up with that final number, you might want to consider doubling that for both parents. That way, if something were to happen to both you and your partner, your children and other financially-dependent family members would have sustainable income well into the future. Alternatively, each spouse could complete the Dime Formula independently for their own life insurance needs.
2. Shortfall calculation
The shortfall approach works backward from the annual income you would want to leave your spouse and family for X number of years. After you decide on this target number, subtract all other sources of annual income that will be available to them, such as your retirement accounts, pension, savings, your spouse’s salary and Social Security. The resulting number is the shortfall you’ll want to replace with life insurance.
When using this method, it’s also important to include all of your assets. If you’re starting to save for retirement, for example, you’ll likely have more assets in the future than you do right now. A life insurance policy may need to account for those future earnings as well.
Factors to consider when buying life insurance
Buying life insurance is a process that typically requires self-evaluation to build the right policy. Considering these factors may also help you narrow down how much life insurance you need:
- Your age: Life insurance premiums generally increase with age. Even if you don’t currently have any dependents, getting a life insurance policy while you’re young may be more cost effective in the long run.
- Age of spouse and children: This helps you estimate how many years of income replacement financial dependents would need if you passed away.
- Mortgage and debts: When choosing a life insurance coverage limit, you’ll likely want to account for your home mortgage, car loans, student loans and other debts into your decision. Most debt does not disappear when you pass away, so your family members would likely become responsible for making the payments.
- College expenses: Educational expenses can be pricey. If you want to support your children and spouse through their future education, you’ll likely want to consider how many years of school they may pursue and the rising cost of education.
- Your current income: If you have no outstanding debt, no major future expenses (like college tuition) and have a healthy savings account, you may not need to replace your full income.
- Funeral expenses: The average cost for a burial or cremation, funeral and related expenses runs around $7,000. You may want to purchase enough life insurance to cover those end-of-life costs.
Choosing your life insurance policy
In addition to deciding how much coverage you need, you’ll also need to decide what type of life insurance is best for your needs. The two main types of life insurance are term life insurance and permanent life insurance. Under the umbrella of permanent life insurance, there are several different policy types, like whole life insurance and universal life insurance.
Term and permanent life insurance differ in a few key ways. First, term life insurance offers protection for a certain amount of time, usually between 10 and 30 years, although shorter and longer term lengths may be found with some insurers. Permanent life insurance, on the other hand, offers lifetime protection under most circumstances as long as you continue paying the premium.
Term life insurance is usually the cheapest option while you are young and healthy. However, the premiums may get more expensive with age. Permanent life insurance may have more expensive premiums, but it provides the added benefit of cash value. With each premium payment, your cash value grows in a savings account, and once you hit a minimum threshold, you can withdraw or borrow the money at any time for any purpose.
While cash-value life insurance products do offer some benefits, returns may fluctuate depending on your policy type, so it may be best to speak with a licensed financial professional before purchasing a policy with a cash value component.
So, which policy is right for you? Your individual circumstances may provide the best guidance in dictating whether to choose a permanent policy, term insurance or a combination.
Frequently asked questions
The main difference between term life and whole life is the length of time you’re covered. Term life insurance provides coverage for a set period of time, typically between 10 and 30 years. Whole life insurance does not have an end date like term life insurance does. As long as you keep paying your premiums and follow the carrier’s requirements, your whole life policy should remain in force until you pass away.
Life insurance riders could offer flexibility in personalizing your life insurance policy. If you’re wondering how to choose life insurance riders, consider starting by exploring the options different life insurance companies offer. From there, you could also speak with a licensed life insurance agent to determine which ones may help build the best life insurance policy for you and your family.
Yes, you can have more than one life insurance policy. Purchasing multiple policies may be strategic, like in the case of laddering your life insurance (a process that involves stacking multiple term policies). However, before you purchase more than one life insurance policy, you may want to review the potential benefits and drawbacks of this strategy and speak to a licensed life insurance agent to see if it could be right for you.
Many life insurance companies sell quality policies designed to meet your life insurance needs and fit your current budget. To find the cheapest life insurance, get quotes from several insurers to compare. Make sure you are comparing similar products and the same amount to get the best (and cheapest) life insurance. Unlike other types of insurance, like auto insurance, life insurance premiums might not vary as much between carriers.