How Much Life Insurance Do You Need?
Now that you have made the decision to buy life insurance, you must first decide exactly how much life insurance you need.
Of course, you can’t pinpoint the amount you’ll need down to the penny, but you can find a solid estimate which will adequately cover your loved ones in the event of your death without breaking the bank with high premiums along the way.
The key things to remember are it depends on your long-term financial goals, overall assets, and the type of life insurance you qualify for and want to purchase.
Here’s everything you need to know about how much life insurance you need.
Let’s Talk About The Importance of Life Insurance First
The importance of life insurance simply cannot be overstated.
Chief among its benefits is protecting your family in the event that you pass away. Your beneficiaries will receive an influx of cash to help deal with the financial aspect of your death.
Many policies also come with final expenses. These are commonly used for your funeral and burial expenses as well as paying any outstanding debts.
Other benefits of life insurance include a variety of tax benefits, a cash accrual option, and the ability to earn dividends on an annual basis.
Three Common Formulas (#1 Is Most Popular)
There’s no one single way to calculate how much life insurance you need.
Most people find a base figure by considering their long-term financial obligations first. Do you have a mortgage? Do you have children? Is your spouse financially dependent upon you?
Next is subtracting your assets from these obligations. What is left in the gap between your financial obligations and assets?
The goal of life insurance is to fill that gap. The goal of life insurance is to provide enough for your dependents financially if you pass away.
Three of the most popular ways to further narrow this figure include:
1. Multiply Income By 10
The traditional rule for calculating life insurance is to multiply your income by 10.
The resulting figure is how much life insurance you need. In days gone by, 10 times the income was usually enough life insurance coverage.
However, the rule doesn’t work as well today. It’s outdated. The reason is that it fails to consider both your family’s specific needs as well as your assets (including existing life insurance policies).
It also doesn’t consider both spouses in a marriage. If you have kids, it’s especially important for both spouses to buy their own life insurance, rather than just the main income earner (if there is only one).
2. 10 Times Income Plus $100,000 Per Child
One way around the outdated 10 times the income rule is to multiply the income by 10 and then add $100,000 per child.
Once again, this rule is still slightly outdated. However, it does bring a more accurate figure, especially if both parents buy such a policy.
This rule for calculating life insurance takes into consideration the cost of education for each of your children, hence the additional $100,000.
Still though, nowhere does it consider your family’s individual needs or assets.
3. DIME Formula
The DIME Formula is a much more accurate way to calculate the amount of life insurance you need.
Broken down, DIME stands for debt, income, mortgage, and education. These are the four main areas you should think about when figuring out how much life insurance to buy.
The formula goes like this:
- Debt – Add debts (except mortgage)
- Income – Multiply income by number of years to support family*
- Mortgage – Add how much you have left on mortgage
- Education – Add estimated cost of sending children to college
* Figure out the number of years left to support your family by considering how long you’ll have dependents. A common method is to calculate the number of years under your youngest child is finished with high school or college.
What Should You Do?
Any of the three methods above, especially the DIME Formula, will give you a reasonable estimate on the amount of life insurance to buy.
However, we still urge you to think about it on your own. Namely, strongly consider your financial obligations and liquid assets.
One of the easiest ways to come up with a figure is to subtract your assets from your financial obligations. As mentioned above, the remainder is the amount of life insurance you need.
How Long Should Your Coverage Last
Not all life insurance coverage is permanent.
Though whole life policies do last forever, term life policies only last for a predetermined length of time.
Here are four common ways to decide how long your coverage should last.
1. Permanent Policy
A permanent policy is the length of coverage we had in mind when outlining how much life insurance you need above.
These policies last for your lifetime. They continue to provide coverage for your children, spouse, and other dependents until you die – whenever that is.
We recommend that everyone looks into a permanent whole life policy first, even if only to gauge the cost to them.
2. Length of Mortgage
A mortgage is one of the biggest expenses many people have.
In fact, a mortgage payment is one of the most common reasons to buy life insurance. People want to ensure that their loved ones will be able to continue making payments after they pass away.
This is why the length of your mortgage is a good term length if you’re looking into term life coverage instead of a whole life policy.
3. Until You Retire
The goal is to save enough to comfortably live off of before you retire.
If you’re on track to meet this goal, you might consider a life insurance term that ends around the time you retire.
At this point, your children are likely living on their own, your mortgage is paid off, and you have a comfortable amount of retirement savings to live off.
If the main reason you bought your life insurance was income replacement, ending a term life policy after retirement isn’t a bad idea.
4. Until Children Are on Own
Perhaps the main reason you purchase life insurance was to protect your children in the event that you pass away.
That’s why many people with this line of thinking buy life insurance in a term that ends around the time their children finish high school or college and start living on their own.
At this point, most of the huge expenses associated with raising children have already been paid off.
Tips to Keep in Mind
The two top tips to keep in mind regarding life insurance are: 1) don’t skimp 2) consider it as part of your overall financial plan.
Always buy just a little more coverage than you think you need. Don’t skimp and buy the exact amount your calculations dictate. Always buy just a hair more.
Think of your life insurance policy as part of your overall financial plan. Know that your income (and expenses) will probably grow in the future. Many people have their financial advisor help assist them when buying life insurance.
And, remember, that you can usually revisit your life insurance policy to add more coverage at certain points during its term.
Everyone requires a different amount of life insurance, depending on a number of factors.
At LifeInsuranceDiabetics.com, we’re committed to help you get exactly what you need; no more, no less.
The key is to consider your own specific situation, most importantly your long-term financial obligations and assets, to come up with a figure.
Always run this figure by a financial expert first. As mentioned above, it’s much better to buy a little too much life insurance than too little.