Calculating How Much Term Life Insurance You Need
Calculating How Much Term Life Insurance You Need
Perhaps you know you need life insurance, but you’re not quite sure how much. Life insurance is an important purchase. The death benefit from a life insurance policy can save a struggling family that loses a provider. Understandably, you want to make sure you buy the right amount.
The “right amount” of life insurance is different for everybody. Life insurance is not a one-size-fits-all product. The amount you need depends on your finances, financial goals, and family situation.
There are many different types of life insurance, such as term life insurance, whole life insurance, and universal life insurance. Since term life insurance is the best option for most families, that’s what we will focus on.
What is your annual income?
The main point of life insurance is to replace your income if you die so your family doesn’t financially suffer. Your family’s standard of living is provided by your paycheck. If that paycheck were to suddenly disappear, what happens to your family?
The rule of thumb is for providers to buy enough life insurance to cover ten times their income. But life insurance is not one-size-fits-all. Ten times your income may not be enough or it may simply be unaffordable for families on a budget. Multiplying your income by ten is a good starting point, however, and you can adjust as necessary from there.
For stay-at-home parents that don’t provide a paycheck, think of all the services you provide for your family. How much would it cost to replace these? Your spouse would either need to find time to do it all or hire help like a nanny and a housekeeper.
The annual cost to replace a stay-at-home parent’s contribution to a family averages $145,000 across the United States. This shows that parents who work inside the home need life insurance just as much as parents who work outside the home.
What debt (good and bad) do you have?
Do you have debt that may fall onto your family’s shoulders if you died before it was paid off? Your mortgage is the most important type of debt to consider when buying life insurance. If you died tomorrow, you’d want your family to be able to afford to stay in their home. Selling a home under duress on top of the emotional turmoil of losing a spouse and parent would be devastating.
Do you have student loans that a loved one would become responsible for? If you live in a community-property state, your spouse may become responsible for the balance. If your loans were co-signed, the co-signer would become responsible. Student loan debt can be substantial. Consider this amount when buying life insurance.
Other types of debt to consider when buying life insurance include: car loans, credit card balances, personal loans, and home equity loans. Read more about how debt is passed on after death in this blog: What Happens to My Debt When I Die?
Do you plan on contributing to your children’s college education?
If you plan on helping your kids out with college tuition, consider this cost when buying life insurance. You can use the estimates below and then multiply the numbers by how many children you have.
These are the average yearly tuition and fees costs for the 2018-2019 school year according to the College Board:
- Public two-year in-district = $3,660 (with room and board = $12,320)
- Public four-year in-state = $10,230 (with room and board = $21,370)
- Public four-year out-of-state = $26,290 (with room and board = $37,430)
- Private nonprofit four-year = $35,830 (with room and board = $48,510)
Do you want to be cremated or buried?
The cost of a funeral varies drastically. The average cost of a basic funeral and burial in the U.S. is $10,000. The average cost of a basic funeral and cremation is $4,000. However, these averages do not include an obituary, cemetery plot, headstone, flowers, or the memorial service. A memorial service can include a multitude of costs such as catering.
Many often leave their funeral wishes in their wills, but also write them down and store the document somewhere your family can access quickly. Wills need to be filed with the probate court. If you own a lot of property and assets at death, the probate process can take a long time. Funeral decisions likely will be made long before the process is complete.
How much money do you have saved?
The amount you have in your savings, investment, and retirement accounts (such as your 401(k) and IRA) can be subtracted from your life insurance needs total. Your loved ones will be able to access these funds when you die. How long it takes for them to gain access will depend on how you set up these accounts. Also, whether you die before or after retirement age will affect your beneficiary’s options in regards to retirement funds and Social Security benefits.
Assuming you name your spouse as the beneficiary on your retirement accounts, he or she will be able to gain control of these funds fairly quick when you die. If your bank accounts are jointly-owned, the co-owner will be given sole ownership and can access the funds. If your bank accounts are in your name only, then the account may have to go through probate to determine who gets access to it (likely your spouse if you’re married).
If you don’t want to add a second owner to your bank accounts but also want them to skip the probate process, you can name someone as the payable-on-death beneficiary. This is a simple form you fill out and submit to your bank. Another option would be to set up a living trust and put your bank account in it. For accounts you use frequently, it may be more convenient to choose the first option and leave the account in your name versus making deposits and withdrawals in the trust’s name.
Do you currently own life insurance coverage that you plan on keeping?
If you have life insurance coverage through your employer, you can subtract this coverage amount. If you already own an individual life insurance policy and plan on keeping it (versus replacing it with the one you’re currently considering) you can also subtract this amount.
Do you have any other means of income?
If you have other means of income that may continue even after you were to die, such as real estate investments, you can subtract this annual amount. If your spouse or partner also works full-time (and would continue to do so after your death) this annual amount may also be subtracted.
Life insurance is there to replace your income and make sure all the important things you were paying for can still be provided. Even if you were to die suddenly. It can also ensure you don’t leave your family in debt. Essentially, the amount of term life insurance you need is the combination of your financial obligations minus your liquid assets.
Term life insurance is affordable and can fit into most budgets. The coverage options range from $50,000 all the way to over $65 million. However, if you’re thinking through these calculations and then run a term life insurance quote and discover that the amount of coverage you calculated is out of your budget, buy what you can afford. At Quotacy, we always say a $100,000 life insurance policy is a million times better than nothing.
Figuring Out How Long Your Term Life Insurance Policy Should Last
Term life insurance is temporary and only lasts a set amount of years that you choose. This length of time is called a term. Term life insurance can last anywhere from 5 to 40 years.
General advice is to pick the term length that matches your longest financial responsibility. For example, if you have a 30-year mortgage then choosing a 30-year term length is a good choice. If you just had a baby, then choosing at least a 20-year term length to ensure there is financial protection in place as your child grows into an adult is wise. The cost of raising a child isn’t cheap and your income is essential.
Alternatively, choose the longest term length you can afford. The cost of life insurance increases with age. If you decide later on you need more term life insurance, your premiums will be higher for a new policy. We recommend that you buy as much as you can comfortably fit into your budget while your premiums are the least expensive.
Here are some instances when different term lengths make sense:
10-Year Term
- If your children will enter college in a few years and you want to protect them from having to take on student loan debt if you pass away.
- If you are a few years from retirement and you want to provide security for your partner’s retirement years.
20-Year Term
- If you are a young family and you wish to safeguard your children’s financial future until they become independent.
- If you want to protect your family’s estate from long-term business debt that you personally guaranteed.
30-Year Term
- If you don’t yet have children but plan to.
- If you plan to pay off a newer mortgage should you pass away.
- If you want to leave funds to pay for your young grandchildren’s college education.
40-Year Term
- If you’re young and want coverage to last until you’re in your retirement years.
- If you’ve been thinking about permanent life insurance but it’s out of your budget.
- If you have debt that may take some time to pay off and don’t want to leave any behind to your family.
See prices and compare term life policies in under 5 minutes
Maybe You Need More Than One Life Insurance Policy
There’s no rule that says you’re only allowed to own one life insurance policy. For some people, owning more than one life insurance policy to cover a variety of needs is best. This strategy is called laddering.
Laddering life insurance policies can mean buying more than one policy at a time with varying term lengths and coverage amounts, or it can mean owning more than one policy and purchasing them at different intervals. The laddering strategy is ideal if you have different financial obligations you want to cover but don’t want to pay expensive premiums for one large term life insurance policy.
How to Ladder Life Insurance
Buying multiple policies all at once
The graphic above shows an example of a healthy 30-year-old male buying three life insurance policies with varying term and coverage amounts at the same time.
During the first ten years, this policyowner has $400,000 in life insurance coverage to provide financial protection for his family during his children’s most formative years. After ten years is over, Policy #3 drops off and he has $200,000 in life insurance coverage to make sure the family home could be paid for if he died unexpectedly. After another ten years goes by, his children are grown and the mortgage balance is considerably less. Policy #2 then drops off and he’s left with $100,000 in coverage until age 65 to protect his spouse’s retirement plans.
This ladder life insurance strategy is more affordable over the total span of 35 years versus purchasing one 35-year term policy with $400,000 in coverage. And this is because when the individual policies end, the policyowner no longer has to pay those premiums.
Buying multiple policies in intervals
The graphic above shows an example of buying three life insurance policies with varying term and coverage amounts at different intervals. The policyowner is a healthy 30-year-old woman at the start of her first life insurance policy purchase.
This ladder life insurance strategy is ideal for someone who wants life insurance to protect their loved ones, but can’t afford much at first. A little bit of life insurance is better than none. As you grow into your peak earning years, you can purchase more term life insurance as you need it.
Questions? Talk with our experienced advisors.
Term Life Insurance Versus Permanent Life Insurance
We mentioned that term life insurance is the best type of life insurance for most families, but permanent life insurance does have benefits. We’ll briefly discuss the two most common types of permanent life insurance, which are whole life insurance and universal life insurance.
What Is Universal Life Insurance?
Universal life (UL) insurance is a type of permanent life insurance that features flexible premiums and the option to have an increasing death benefit. It trades some of the value growth benefits of a whole life insurance policy in exchange for more flexible payment plans and a lower price.
Why Universal Life Insurance?
A universal life insurance policy is flexible and designed to meet the changes in a person’s life. It can be aggressively funded if the policyowner has the capability and during times of tightened budgets premium payments can be reduced or suspended altogether. The death benefit can also be increased or decreased if needed.
What Is Guaranteed Universal Life Insurance?
Universal life insurance and guaranteed universal life (GUL) insurance are quite different. Guaranteed universal life insurance is essentially a term life insurance policy that can last your entire life.
Why Guaranteed Universal Life Insurance?
Guaranteed universal life insurance has a set death benefit amount that lasts your lifetime at a lower cost than both whole life insurance and universal life insurance. The premiums for guaranteed universal life insurance are less expensive because it does not come with fancy extras such as dividends or aggressive cash value accumulation.
Some guaranteed universal life insurance policies offer policyowners the option to decrease the death benefit if needed. And some guaranteed universal life insurance policies offer a return of premium option. The specifications of these features vary depending on the policy.
Guaranteed universal life insurance is a great option for people who want lifetime coverage but can’t necessarily afford the premiums of the typical permanent life insurance policy.
What Is Whole Life Insurance?
Whole life insurance is life insurance coverage that lasts your entire life. As far as permanent life insurance plans go, whole life insurance is the least complex. As long as the policy is kept active, the life insurance company pays your beneficiary(ies) the policy’s death benefit no matter when you die.
Whole life insurance is typically about 10-15 times more expensive than its term life insurance counterpart. This is because of its lifelong coverage, savings component that builds cash value, and dividends. Whole life insurance coverage amounts range from $10,000 to over $65 million. This is the amount your beneficiary(ies) receive upon your death.
Why Whole Life Insurance?
Whole life insurance lasts your entire lifetime and pays a death benefit when you die (not if you die like term life insurance.) Whole life insurance policies are used to fulfill financial obligations at the end of one’s natural life.
Whole life insurance can ensure that your final expenses are taken care of, even if you plan to spend your retirement savings. People often purchase whole life insurance to have money to make sure that their children receive equal amounts of inheritance or are able to pay estate taxes to keep control of family property.
We mentioned that term life insurance is the best type of life insurance for most families, but permanent life insurance does have benefits. We’ll briefly discuss the two most common types of permanent life insurance, which are whole life insurance and universal life insurance.
Buying Both Term Life Insurance and Permanent Life Insurance
Just as you can ladder multiple term life insurance policies, another great strategy to consider is buying a large term life insurance policy and a small permanent life insurance policy. Purchase enough term life insurance coverage for your big ticket financial responsibilities (such as the mortgage and providing for your children from infancy to adulthood) and supplementing it with a small permanent life insurance policy to cover final expenses and leave some money behind for your loved ones.
Example of Term With Permanent:
John is 30 years old. He’s an assistant account executive at an established advertising firm. He contributes 6% of every paycheck to his 401(k).
At 32, John gets married. He and his wife each purchase a $500,000 30-year term life insurance policy naming one another primary beneficiaries. His premiums are $35 per month.
At 33, he and his wife also each purchase a $50,000 whole life insurance policy naming one another primary beneficiaries. His premiums are $56 per month.
When John is 34, he and his wife welcome their first child.
At 35, they buy their first home. In this same year, he’s promoted to account executive and receives a raise. He also opens an IRA account and contributes $200 to it each month.
When John is 36, they welcome their second child.
At 53 years old, John’s $50,000 whole life insurance policy has a cash value of $12,221. If he desired, John could withdraw funds from this total via policy loans.
At age 55, John and his wife are officially empty nesters.
At age 60, they send in their last mortgage payment.
At age 62, their term life insurance policies end. Their whole life insurance policies are still active.
At age 67, John retires.
*The life insurance rates in the example are for illustrative purposes only. Your life insurance premiums may be higher or lower.
Considering this example, if John were to unexpectedly die anytime between the ages of 32 and 62, his wife would receive a death benefit of $500,000 from the term life insurance policy and $50,000 from the whole life insurance policy.
If still alive at age 62, John’s term life insurance policy ends but his whole life insurance policy is still active. As long as the premiums continue to be paid to keep the policy inforce, John’s wife will receive the $50,000 death benefit no matter when John dies. However, if John has any outstanding policy loans at death, this amount plus interest will be taken from the total death benefit amount.
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.