How Much Life Insurance Do I Need?
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What is life insurance?
Life insurance is financial protection for the loved ones you leave behind upon your death. A life insurance policy provides a pool of money your family can draw upon to pay bills and sustain their standard of living.
Whether this is financial protection for a specific number of years or active coverage your entire life, life insurance is a responsible way to safeguard your family’s future.
Two Types of Life Insurance: Term and Permanent
Term life insurance provides coverage for a specific number of years. This term of protection can last between 10 and 40 years, depending on your age. If you die unexpectedly at some point during this term, your family is paid the death benefit.
Term life insurance is the most affordable type of life insurance. The premiums are also fixed which means you lock in your price when you buy the policy. Your term life insurance premiums will not increase as you age or even if you are diagnosed with a serious medical condition.
Permanent life insurance is designed to provide coverage your entire life. When you die, your family receives the policy’s death benefit.
Permanent life insurance has more features than term life insurance. These features, plus the fact that they are usually priced to last your entire life, makes permanent life insurance far more expensive than term life insurance.
Learn more: Term vs Whole Life Insurance
Who needs life insurance?
If you’re married or have a long-term partner, then you should have life insurance. If you have children, you need life insurance. Essentially, if there is anyone who relies on you, then life insurance can help you financially protect their future.
When you have a family, you have a responsibility to take care of them. Your income provides for their standard of living. If you die, what happens to them? This is when life insurance becomes life saving.
How much life insurance do I need?
Life insurance needs vary by your circumstances. Do any of the following pertain to you? The more that do, the more life insurance you need.
- Are you married?
- Do you have a mortgage?
- Do you have children?
- Do you plan on paying for your children’s college education?
- Is your spouse a stay-at-home parent?
- Do you own a business?
- Do you have debt that becomes someone else’s responsibility if you die?
- Do you take care of any aging or dependent relatives?
- Is your estate large enough to wind up owing taxes?
When all is said and done, the human body itself is not worth much. But when dependents or an organization relies on you, you may be worth millions. So, how much are you worth?
A $500,000 or $1,000,000 life insurance policy may sound like a lot, but these face amounts are some of the most common policies purchased by family providers. We recommend that you buy as much term life insurance as you can comfortably afford.
As you’re planning on buying life insurance, sit back a moment and think of everything your income currently provides. Then think of everything in the future your family will need money for. These responsibilities add up.
With term life insurance, large amounts of coverage are relatively inexpensive. If something happens to you, you can still financially protect the loved ones you leave behind with a life insurance policy. You can take pride in knowing you’re shielding them from financial harm should you die unexpectedly.
How to calculate how much life insurance you need
Life insurance is not one-size-fits-all. There are different ways to calculate how much life insurance you need.
1. Using Rule of Thumb to Calculate Life Insurance Needs
This is the most basic way to calculate how much life insurance you need. With this method, you simply take your annual income and multiply it by 10.
Example: Your gross annual income is $50,000. Multiplying this by 10, your estimated life insurance needs equal $500,000.
By multiplying a provider’s income by 10, a family can theoretically continue to pay typical expenses and maintain their same standard of living for the 10 years following the provider’s death.
However, this method does not take inflation into account. Nor does it consider an individual’s circumstances such as the person’s age, whether the spouse works, children’s ages, or outstanding debt.
2. Using the Income Replacement Approach to Calculate Life Insurance Needs
This method uses human life value which takes into consideration after-tax income, inflation, and growth rates. Essentially, this approach says that the amount of life insurance coverage you need is equal to how much you will earn until you retire.
Example: Your gross annual income is $50,000. You plan on working 20 more years.
Using a financial calculator with inputs of a 5% return on investments, 2.9% inflation rate, and 3% income growth, your human life value is $1,042,423.
Human life value isn’t a very precise estimate of your family’s life insurance needs. It doesn’t take into account family assets or additional sources of income, investments, or Social Security survivor benefits. Nor does it consider expenses that occur after the death of a provider such as final medical expenses, funeral costs, estate settlement expenses, and debt repayment.
3. Using a Goal Based Approach to Calculate Life Insurance Needs
With this approach, you simply purchase enough life insurance to cover specific goals. These goals tend to also be the reasons behind buying life insurance in the first place.
Example: You have a family and a mortgage. If you died tomorrow, you want your family to remain in your home and still provide for your two children’s college education.
Remaining mortgage: $200,000
In-state 4-year college tuition and fees: ($11,000 x 4 years) = $44,000 x two children = $88,000
Total life insurance needs to cover goals = $288,000
These goals, of course, differ among individuals, as do the prices attached to them.
This approach is simple, but fails to address many other financial needs.
4. Using a Needs Based Approach to Calculate Life Insurance Needs
This method is more customized to an individual’s situation. It takes into account a family’s needs, debts, expenses, and their future.
Essentially, this approach suggests you first add up all your debts, expenses, and the income you need to replace. It’s assumed that your income covers everyday things such as food, clothing, utility bills, and transportation so there is no need to calculate these things separately.
Then, subtract out assets your family would have access to such as savings, stocks, bonds, mutual funds, and existing life insurance policies.
- Debts and Expenses:
- Mortgage = $200,000
- Children’s college: $88,000
- Credit card debt = $10,000
- Funeral expenses = $20,000
Annual income = $50,000 (then divide by 4% which is a conservative interest rate for investments)
So far, life insurance needs equals $1,568,000.
Subtract from this number funds you currently have in savings and investments and the face amounts of any other life insurance policies you may have.
- Savings Account = $5,000
- CDs = $15,000
- Group life insurance = $50,000
- 401(k) = $80,000
$1,568,000 – $150,000 = $1,418,000 (your life insurance needs)
This method provides a relatively accurate life insurance needs analysis.
Which life insurance needs calculation should I do?
If you have a financial planner, this person will help you determine your life insurance needs. They are knowledgeable in the different calculation methods.
However, not everyone has a financial planner. Your Quotacy life insurance advisor can help you determine your life insurance needs at no extra charge.
If you’re ready to buy life insurance to protect your family but aren’t sure how much, contact us directly. We can help.
We also have a life insurance calculator you can use to get an idea of how much life insurance you need. Simply enter a few numbers and our calculator suggests a coverage amount. You can then continue onto the quoting tool and instantly see quotes for this suggested amount.
Not sure how much term life insurance you need?
Do I need term life insurance or whole life insurance?
Most families only need term life insurance. This coverage is affordable and provides protection for your loved ones during your most financially vulnerable years. These are the years that begin when you start a family—whether that’s just you and your partner, or you, your partner, and children—and taper off as you get nearer to retirement.
You want to buy enough term life insurance to replace your income and pay off your debts. You don’t want to leave your family struggling to pay bills if you die unexpectedly.
Some families benefit from whole life insurance. While these premiums are much higher than term life insurance, this policy lasts your entire life and has features such as cash value accumulation.
If you buy a whole life insurance policy, it’s not uncommon to buy this in addition to a term life insurance policy. The term life insurance policy covers your big ticket item, such as a mortgage, at a much more affordable cost. The whole life insurance policy then covers end-of-life expenses, such as medical bills, funeral cost, and estate taxes. It can also provide for an inheritance, if that is one of your goals.
Do I need more than one life insurance policy?
You don’t need more than one life insurance policy, but in some cases it makes sense.
You have both short and long-term financial responsibilities.
If you have both short-term and long-term responsibilities to provide financial protection for, it’s common to own both a term life insurance policy and a type of permanent life insurance.
Most often, the term life insurance policy has a large face amount to cover all your big ticket items. The expenses your loved ones would immediately need to pay for and bills to keep up with if you died unexpectedly. Bills such as the mortgage, college tuition, a funeral, credit card debt, and car payments.
The permanent life insurance policy protects your spouse’s retirement. The death benefit allows your spouse to pay bills without dipping into retirement accounts. A permanent policy can also enhance your retirement if you choose to take out tax-free loans against the policy’s cash value for supplemental income.
If your estate is large enough to be taxed, permanent life insurance can help protect your estate from estate taxes.
Permanent life insurance also provides a guaranteed payout for final expenses no matter when you die, unless you choose to surrender the policy.
If you have a dependent who will rely on you for their entire life, such as a special needs child or aging parent you’re taking care of, this is when a permanent policy is important as well.
You have multiple goals to protect.
Laddering term life insurance policies can be an efficient way to protect many financial obligations. This is when you buy multiple term life insurance policies with varying coverage and term lengths. These policies are designed to overlap coverage during the years of your life you need the most protection and then slowly drop off.
For example, if you have three purposes for buying life insurance such as protecting your spouse financially until he or she is retired, supporting children through college, and making sure the family can remain in the home, three policies can help.
Since these responsibilities all come with pretty hefty price tags, buying three separate term policies versus one policy with a large face amount can be a more affordable strategy.
Learn more: Laddering Life Insurance to Save Money
You have group life insurance.
If you have a group life insurance policy through your employer, it’s perfectly legal to buy your own life insurance policy. In fact, it’s highly recommended.
Having your own life insurance policy with a group policy for extra protection is a wise move.
Do I need life insurance if I have a policy through my employer?
You absolutely need your own life insurance policy even if you have group life insurance coverage.
This is why:
- Your life insurance policy through your employer isn’t owned by you. The employer can choose to change or eliminate benefits at any time which terminates your policy. If you leave the company, whether voluntarily or involuntarily, your coverage doesn’t automatically go with you.
- If your employer’s policy allows you to take your policy with you if you leave (in other words, it’s portable) converting to this policy will increase your premiums.
- Life insurance policies through your employer have limited coverage options. These face amounts are often well under the amount you need to adequately protect your family.
- Supplemental life insurance coverage offered through your employer may tout being “no exam” but you’ll pay for this feature with higher premiums.
- The premiums for the supplemental coverage are not fixed. They increase as you age.
- Coverage often ends at a certain age, typically 70-75.
Life insurance can be customized for your individual needs. Quotacy can help. As a life insurance broker, we’ll shop the market to find you the best life insurance rates.
Questions? Talk with our experienced advisors.