Term life insurance coverage is designed primarily to replace a person’s income if they pass away unexpectedly. Most people only need to plan for replacement income for a few years to help their family bear the burden of living expenses without the benefit of another income, and many also use insurance policies to pay off their mortgages and debts. But some individuals require even larger policies to cover other financial needs, like keeping a business alive, or cementing a legacy through a charitable gift, or helping to divide up a large estate equally among their family and offset estate taxes.
Life insurance is designed to do this as well, but individuals looking for larger-than-average face amounts on their policies will often begin to run up against some new hurdles when it comes time for their policy to be underwritten. When an individual is asking for 30 times their annual income as the face amount of a policy, the insurance carrier will often come back with one simple question: “Why do you need all of this money?”
Insurance carriers require a financial justification for large policies because life insurance is designed to replace wealth, not increase it. Just like a car insurance policy can only cover the value of a car and no more, a life insurance policy can only cover up to the maximum value of the person being covered. A person’s “Insurability Limit” is the limit to the amount of total insurance that can be inforce on a person at any given time across all of policies that insure their life.
For example, if a person’s insurability limit was at $1 million, and they already had an inforce policy for $750,000, another carrier would not issue a $500,000 policy on top of the existing coverage without changes in coverage or surrender of that existing policy.
While there’s a little more wiggle room in the price of a human life than the price of a car, there are still limits on how much financial compensation you can arrange with a life insurance policy. A carrier takes into account your current income, net worth, and any other assets or income streams you have access to in order to determine the maximum amount of coverage they’re willing to offer.
Rule of Thumb
The general insurance rule for most people is that if you’re 40 or younger, your life can be insured for up to 25 times your current annual income. Every ten years after age 40, that multiplier is reduced by 5. That means that from ages 41-50, you can get 20 times your annual income in coverage, 15 times your income from age 51 to 60, and 10 times your income until age 70.
Because most people are retired by the time they hit 70, insurance carriers are more hesitant to offer policies to just replace a person’s income, and their underwriters will review requests for large amounts of coverage on a case-by-case basis, mostly based on a persons net worth and estate tax considerations.
For example, if you’re a 30-year-old making $50,000 annually, your maximum insurability limit is around $1.25 million – 25 years’ worth of income. Even people that don’t have a source of income, like stay-at-home mom or dad, can be covered with life insurance, since their work at home takes the place of a dizzying number of costs.
Insurance carriers each have individual rules regarding the amount of coverage they can offer to non-working parents. This ranges from half of their spouse’s coverage limit all the way up to a matching policy capped at around $3 million. If you’re a stay-at-home parent, having one of Quotacy’s independent agents help you shop around for a policy can help you get the coverage you deserve.
As you can probably guess, not many people really need to reach the limits of their insurability, and the price of a maxed-out policy is often cost-prohibitive. For most people, a better question to ask is “how much life insurance do I need?”
Assessing Your Insurance Needs
When determining how much life insurance to buy, we recommend using a 2-step process to determine how much coverage you need. First, put enough into your policy to replace your current income for the amount of time it will take for your family to be back on firm financial ground. Second, add additional coverage for any additional debts your family will need to pay off, like your mortgage, or a child’s college tuition.
Our online life insurance needs calculator lets you play with your monthly income and debt to be repaid to help you get an idea of how much coverage you should apply for, and you can easily get accurate quotes for your recommended policy on our site as well, all without giving us your contact info.
If you decide to apply for coverage through us, but still aren’t sure about your face amount, you can always ask your Quotacy agent for financial advice, and they’ll be able to give you some expert suggestions based on your unique financial situation.
Photo credit to AisleTwentyTwo