How Much Life Insurance Do I Need

Variable 1

    How Much Life Insurance Do I Need: A Guide To Calculating Your Coverage

    how much 1

    Most of us know how important it is to buy life insurance. For many, it's a necessary safety net that helps their loved ones stay afloat when they're gone. And yet, a 2020 study found that nearly half of U.S. adults do not own insurance, with most blaming cost as their number one reason for avoiding it.

    But the same study also found that half of millennials overestimate the annual cost of a term life insurance policy for someone their age. In fact, life insurance doesn't have to be expensive at all. That is, as long as you know how to compute your coverage.

    Here, we'll help you answer some of the most frequently asked questions about life insurance, such as "how much life insurance do I need?" and "how can I calculate life insurance for myself?"

    Who Needs Life Insurance?

    While life insurance can help a lot of people, it's not necessary for everyone. Before you start computing how much life insurance you need, consider whether you even need it in the first place. Here are a few questions to ask yourself:

    • Do I have a child (or am I planning on having one soon)? If you're a parent or are planning on being one in the future, you'll need to make sure your children will be taken care of in case you pass away unexpectedly. Your life insurance should cover the cost of their basic expenses and education until they've reached adulthood.
    • Does my spouse (or soon-to-be spouse) rely on my income? If you're married to someone who can't work, you'll also need to provide them with enough money to replace your income when you're gone.
    • Do I (or will I have to) support my parents or older relatives financially? While it's common practice for people to save for retirement, some folks just don't have the resources to do so. If your parents aren't as financially secure as they need to be and are entering their sunset years, it's a good idea to include their basic living expenses in your life insurance coverage.
    • Am I a business owner? If a key employee or a business partner passes, the business may be entitled to a certain amount of funding to cover the losses. Having life insurance will help you keep your business afloat in the event of an unfortunate circumstance.
    How much 2

    Calculating Your Life Insurance Coverage

    Now that you know whether you need life insurance or not, let's talk about your coverage. Calculating life insurance coverage may seem complicated and daunting, but in reality, it's quite simple. All you have to do is follow this formula:

    [Financial obligations] minus [existing assets] = The insurance you need

    Now, let's break down the terms:

    Financial Obligations

    Financial obligations are the things your dependents will have to pay for when you're gone, from living expenses to debts you've incurred when you were alive.

    • Monthly expenses: To get the value of this, compute your average monthly expenses at home with the number of years you want to cover. Make sure this covers everything your spouse and children will have to spend on, from food to electricity to minor luxuries.
    • Mortgage: You'll want to make sure your family gets to stay in your home long after you're gone, so don't forget to include any balance left on your mortgage in the computation.
    • Auto loan: The same goes for any car loans you're still paying off. If you want your loved ones to keep using your car/s, make sure they have enough funds to pay off the loan.
    • Credit card debt: If you pass away with an outstanding credit card debt, your estate must pay for your debt.
    • Childcare and tuition: If you have young children, make sure your life insurance covers for child-rearing, from their basic needs up to their college tuition, boarding, and commute expenses.
    • Final expenses: Also called end-of-life expenses, final expenses are everything your loved ones have to pay for once you pass. This includes medical bills, hospice care, and funeral costs. Some people opt to get separate burial insurance so that they don't have to factor in their funeral costs in their life insurance policy.

    Assets

    Your assets are anything that your loved ones can use to pay for bills and future expenses. These include:

    • Investments: Stocks, bonds, mutual funds, and the like are all valuable assets that can help keep your family afloat when you're gone.
    • Retirement: Whether you have a 401(k), IRA, or both, these types of accounts can be named to a beneficiary who can access the funds when you pass.
    • Existing life insurance: Some people have more than one kind of life insurance, especially if they're employing the laddering strategy. This means that they'll acquire different kinds of term life insurance to cover different phases of their life.
    • Burial insurance: This is a type of insurance that covers the expenses incurred when you die, from funeral fees to cremation. This insurance helps make the bereavement process easier on those left behind.
    How much 3

    3 More Guidelines For Determining How Much Life Insurance You Need

    Aside from the formula stated above, there are other rules of thumb that can help answer the question "how much do I need for life insurance?" Here are three of the most common ones:

    Multiply By 10

    Some folks believe that your life insurance coverage should be the equivalent of about 10 times worth your annual income. This isn't a hard and fast rule – it doesn't even have to be 10. Some people multiply their income by seven or eight, others go as big as 15. The point is to make sure that your life insurance policy can cover roughly 10 years from your death.

    However, this trick doesn't account for inflation, nor does it take into account your other assets, such as your investments and retirement funds. This means that if you follow this rule, there's a high chance that you could over-insure yourself.

    The Dime Formula

    DIME stands for debt, income, mortgage, and education. Essentially, you add up the total value of your existing debts, your income multiplied by the number of years you want to support your family with your life insurance, your remaining mortgage balance, and the estimated cost of school and college tuition for your children.

    Annual Income x Years Till Retirement

    Finally, another common way to calculate how much life insurance you need is by multiplying your annual income by the number of years you have left until your retirement.

    For example, a 52-year-old woman makes $65,000 a year. She must then multiply 13 years by 65,000. So she will need life insurance coverage amounting to a total of $845,000.

    How much 4

    Factors That Affect The Rate Of Your Coverage

    When computing your coverage, you have to keep in mind that certain factors can affect your rates. Knowing how and why these factors can make an impact on your coverage can help you make better financial decisions.

    Your Health And Age 

    The younger you are, the more affordable insurance premiums will be. In fact, according to Investopedia, life insurance premium rates can jump by 8 to 10 percent for every year of age. This is because the older you get, the more susceptible you are to getting sick, and the higher the likelihood is of you passing away. For life insurance companies, this means there's a greater risk of your beneficiaries needing the death benefit.

    The same goes for health. Many life insurance companies require their policyholders to take a medical exam as part of the underwriting process to determine their overall health. They check your blood pressure, cholesterol levels, and family history of diabetes, heart disease, and stroke. The more unhealthy they deem you to be, the more expensive your insurance will be.

    But, it's also good to note that the older you get, the less coverage you'll need too. This is because you'll have fewer years on your life left and you will hopefully have more assets and fewer beneficiaries depending on you.

    Your Lifestyle

    When screening applicants, another thing that life insurance companies look at is the person's lifestyle. Engaging in high-risk activities like scuba diving, surfing, and race car driving can signal red flags to life insurance providers. They also look at activities and habits that are detrimental to one's health, like smoking and drinking.

    how much 5

    The Type Of Insurance You Get

    The type of policy you choose also affects how much life insurance coverage you'll get. There are two main types of insurance: term life insurance and whole life insurance. 

    Term insurance lasts for a specific time called a term and is typically cheaper than whole insurance. You can get term life insurance for anywhere between 10 and 30 years. Whole insurance, on the other hand, gives you coverage up until the day you die. It can be up to 10 times more expensive than term insurance, but it does come with more benefits. 

    Most whole life insurance packages give a policyholder a cash value, which is a tax-deferred investment account where they can keep their money and let it accrue interest over time. When the policyholder passes away, the policyholder's dependents receive both a tax-free death benefit and a lump sum from the cash value.

    Your Dependents’ Health And Age

    When computing your coverage, you should also consider the overall health of your dependents. If you have a special needs dependent or a beneficiary with a disability or chronic illness, you'll have to account for how much money it will cost to pay for hospitalizations, medication, physical therapy, home care, and hospice.

    Your dependents' age also comes into the equation. If you have young children, you should make sure you leave them with enough money to survive until they're old enough to work and have their own source of income. Your insurance plan should cover their daily expenses, as well as their educational needs such as school and college tuition, boarding, commuting expenses, school supplies, and the like.

    Final Thoughts

    It may seem daunting at first, but figuring out how much life insurance you need is fairly straightforward. All you need is to know what your financial obligations are and how much you have in terms of assets. Once you have that down, you'll be able to compute your coverage and avoid over- and under-insuring yourself.

    Life insurance is one of the most valuable, and oftentimes necessary, financial decisions you can make, especially if you've got people depending on your income to survive. Whether you're taking care of your elderly parents, the sole breadwinner among your sibling, or a newlywed starting a family, buying life insurance can give you the peace of mind that, no matter what happens to you in the future, those you hold near and dear to you will have the money to thrive even in your absence.

    At Wesley LLC, we have a team of financial experts ready to address any and all concerns about insurance – helping you choose the best policy and coverage to suit your needs. Contact us to get started on your journey towards a financially secure future today.

    Written By Cameron McDowell
    Follow the author on:
    arrow-up