How much life insurance do I need?
Is $100,000 enough life insurance? Is $1 million? Or do I need more?
There is no simple answer because everyone has different family needs, financial situations, and outlooks on life.
For some, life insurance is there in case of a disaster. For others, it is a more comprehensive tool for meeting financial needs and estate planning for beneficiaries and loved ones.
Here’s the good news: There are many types of life insurance to meet just about all coverage needs. And there are several approaches I’ve included to help you determine just how much you need.
Let’s see which one is right for you.
What is the best way to determine how much life insurance I should buy?
There are several options used by the insurance industry. The right one for you is based on your personal situation.
- Income Replacement. The industry has traditionally used a 10x rule of thumb multiplier of income for this calculation. If your current income is $100,000, you would need $1 million in life insurance. Another variation of this approach is using the 10x multiplier plus $100,000 per child for college education.
- Cost Based. Identify a percent of your annual income that you can afford to devote to life insurance, with 1-2% being the typical range. For example, 2% of a $60,000 annual salary is $1,200, or $100 a month. A healthy 40-year-old male could qualify for $1 million or more of 20-year term life insurance with life insurance rates less than $100.
- D.I.M.E. This stands for debt, income, mortgage, and education. Total all your debts, including loans, credit cards, etc. Multiply your annual gross income by the number of years your loved ones will need this income. Include your current mortgage balance. Last, total the amount needed to send your children and/or spouse to school. Also include funeral costs. Add these up for your total life insurance needs.
Of these, the DIME method is our preferred approach. If your situation is more complex, you may want to consult a financial professional.
What factors go into life insurance calculations?
There are several big buckets of financial obligations that should be in your calculations:
- Income
- Recurring Monthly Expenses
- Education Expenses (Short and Long Term)
- Healthcare Expenses
- Estate Taxes
- Final Funeral Expenses
- Emergency Funding
Many people underestimate their recurring monthly living expenses and outstanding debt. Here is a good starting list:
- Mortgage Payments
- Utilities
- Food
- Loans, e.g., car loans
- Credit Card Debt
- Healthcare
- Medicine
- Transportation
- Child Care
- Education, e.g., college Tuition
- Clothing
- Contributions
- Pets
- Entertainment
Don’t forget to include savings and investments in your calculation. Traditional savings accounts, a 529 plan for college costs, and short- and long-term investments could have a significant impact on lowering your actual life insurance needs.
What type of coverage should I purchase?
There are two primary types of life insurance: term and permanent. Inside these two types are many different insurance products to meet a variety of needs.
Term Life Insurance Policy
Term life insurance is for a fixed time period, typically 10, 20, or 30 years. Premiums are level and won’t change during the policy term. In almost every case, term insurance is the most cost-effective life insurance.
Term is a favorite product of young families, often purchased when their dependents are young to ensure the policy’s death benefit protects them in the event of the policyholder’s death while the children are living at home.
Permanent Life Insurance Policy
A permanent life insurance policy is designed to provide coverage for the policy owner’s entire life. Permanent policies also have a cash value component or investment component, which devotes a portion of the premium payment to an investment-type account that grows tax deferred.
Permanent insurance comes in a variety of types, including whole life insurance, universal life insurance, indexed life insurance, and variable life insurance. Each provides a different approach to building cash value and growth.
Permanent insurance typically has higher premiums than term.
How do I know which type of life insurance is best for me?
Everyone's personal situation is different. The right type of life insurance coverage for your situation depends on a variety of factors, including health and medical history, age, gender, lifestyle, and other factors. Some policies will require a medical exam.
You can read more about the different types of life insurance here.
I always strongly urge individuals to seek professional help, whether that be a licensed insurance agent or financial planner. Get in touch with me today to start the conversation!
