For years the life insurance rule of thumb has been that you should purchase enough coverage that equals ten times your salary. If you made $50,000 per year buy $500,000 of coverage. If you made $150,000 annually buy $1,500,000 in coverage. Pretty simple to figure out, right? Well, like any rule of thumb, take this advice with a grain of salt.
For example, a single 35-year-old with no children and a salary of $75,000 most likely does not need $750,000 in life insurance. Meanwhile on the opposite side of the spectrum, a stay-at-home parent technically does not have a salary; however, this parent saves the family thousands of dollars in child care alone. Determining your life insurance needs takes a little more finesse than just multiplying your salary by ten.
Determining Your Life Insurance Needs
1. How Much
Life insurance is often referred to as income replacement. You and your family currently rely on a steady stream of money to live. Paychecks provide a place to sleep, groceries, clothing, schooling, doctor check-ups, and many other necessities. If you died prematurely, where would the money come from to continue paying for these things? If you suddenly died in a car accident, that does not stop the mortgage company from requiring a payment or your child asking “What’s for dinner?”
Yes, your salary is an important part of determining how much coverage you need, but what’s more important to consider is what your salary is paying for. Compare the two individuals below.
At first, because Jane has a larger salary and higher mortgage, it may seem like she would need more life insurance coverage than Sally. However, Sally’s children are quite a few years younger than Jane’s so they will be dependent upon Sally for longer. Sally also has more children than Jane which means if she passed away, it would likely take her husband more years to become financially stable without Sally’s income to fall back on.
Using Quotacy’s life insurance needs calculator, it is recommended that Jane apply for $770,000 in coverage and Sally apply for $850,000. (Note: These coverage amounts do not include the cost of providing college tuition.)
2. How Long
How long they want coverage for, in other words, the term length, also differs between Sally and Jane. Not only will Sally need more coverage than Jane, but she should be insured longer than Jane. Sally’s mortgage won’t be paid off for 30 years while Jane’s will be paid off in 15. Sally’s youngest child won’t even be independent for at least 15 years (and, let’s be real, just because you’re a legal adult doesn’t mean you’re financially independent.)
Sally should purchase a 30-year term policy. Using the quoting tool on Quotacy, Sally’s estimated monthly premium for a 30-year $850,000 term policy is $69.79 – dependent upon her health.
Jane could also get a 30-year policy if she wanted but she really only needs a 15- or 20-year term policy.
You want to buy enough life insurance to ensure your family doesn’t struggle financially if you died during their most vulnerable years. You also want to buy life insurance as soon as you need it, not after. The younger you are, the more inexpensive term insurance is. Also, the fewer health issues you have, the more inexpensive it is. Jane can currently purchase a 20-year $770,000 term policy for only $36 per month, but what happens if she decides to postpone applying and then is diagnosed with a medical condition? Instead of being classified as low risk by the insurance company, she’s now moderate to high risk, depending on the diagnosis.
Even if Jane postpones buying a few years and doesn’t develop a medical issue, her premiums will still be higher because she’s older. Being older means you’re that much closer to death – it’s just a fact. If Jane applies for a 20-year $770,000 term policy at age 45 instead of age 40, it impacts the cost.
While a rule of thumb is a good jumping off point, don’t solely rely on it to determine your life insurance needs. Everyone’s family situation and lifestyle is different. If you own a business, that will affect your life insurance needs. If you have a child with special needs, that will affect your life insurance needs. If you care for an aging parent, that will affect your life insurance needs. If you own an investment property, that will affect your life insurance needs.
Try using our needs calculator if you’re looking for a good estimate of how much insurance coverage you should buy. If you’d prefer to talk it through with a live person, you can contact us at any time. We’re more than happy to discuss your insurance needs and answer any questions you may have.
Photo credit to: Alexander Dummer