How Much Life Insurance Do I Need?
There are several types of insurance that you can encounter in life: renters, owners, auto and life. Of all the types of coverage, life insurance is often the most overlooked. Life insurance is invaluable, especially if you have loved ones who depend on you. But figuring out “how much life insurance should I buy” is often the hardest part. There are at least two ways to estimate how much you might need. Before you start calculating, learn about the basics of life insurance.
What is life insurance?
Life insurance provides financial payments in the event of the death of you or a loved one. Depending on the type of policy, life insurance will cover end-of-life expenses – like funerals or unpaid debts – or provide compensation to maintain dependents’ quality of life or future financial needs. This is because life insurance offers a certain guarantee that the financial needs of your beneficiaries will be covered (up to a predetermined extent) in the event of premature death.
Who needs life insurance?
Most people can benefit from a life insurance policy, depending on their circumstances and financial obligation. If you have dependents like children, a disabled parent or sibling, spouse, or anyone else who can depend on you financially, you may be a good candidate for some form of life insurance coverage. . Even if you don’t have any dependents at the moment, life insurance might still be a good option; buying a policy early is a good way to get a lower rate while you’re still young and healthy, until you have dependents.
How Much Life Insurance Do I Need?
The answer to the question of how much life insurance a person needs depends on several factors, including:
- Your age
- The age of your spouse and children
- Your income
- Your mortgage and other debts
- Tuition fees for your children and / or spouse
- The final expense invoice
Your situation may vary the amount of insurance you need in a policy, but expert recommendations also advise thinking about what is most practical for your immediate and future situation.
“You want them to go through this traumatic event with acceptable options, but that’s it,” says Glenn Daily, a New York-based insurance advisor. “A famous agent once said that the whole point of life insurance is to let your family ‘stay in their own world’. This does not necessarily mean that they have to maintain their current lifestyle. Maybe your partner decides to do something completely different.
While there is no hard and fast rule as to how much life insurance you should buy, insurance companies and financial planners have designed templates to help you assess what may be. beneficial. Three approaches are the most common.
1. The DIME formula (and the rule of 10)
The old rule of thumb of “how much life insurance do I need” was to take your income and multiply it by 10. This was industry standards for many years. However, this ignores several things.
Importantly, it does not take into account the living expenses of your family. It can vary wildly if you have a child or four. In addition, it does not offer protection in the event that one of the parents is at home.
As dark as it sounds, what if both parents die and only one is covered? The rule of 10 left many questions unanswered. In its place has come the Dime Formula, which takes into account the following:
- Debt and final expenses: Find a solid number based on all the debts you owe and include the final expense costs for each parent.
- Returned: For income, a good rule of thumb is to think about the number of years your family would need income in your absence. Multiply that number by your annual income.
- Mortgage: Include the total amount owed on your mortgage and assessed property taxes. As with income, think about the number of years your family would need the money for property taxes, then multiply your total annual taxes by those years.
- Education: Figure out the total cost of educating each of your children through high school and middle school.
Once you find this number, double it for both parents. That way, if something happened to both, your family would have a sustainable income in the future.
2. Calculation of the shortfall
The shortfall approach works backwards from the annual income you would like to leave with your spouse and family for X years. After deciding on that target number, subtract all other sources of annual income that will be available to them, such as your retirement accounts, pension, savings, spouse’s salary, and Social Security. The resulting number is the shortfall that you will want to replace with life insurance.
“People forget that they will probably have other assets,” says Tony Steuer, insurance education advocate and author of “Questions and Answers on Life Insurance”. “Right now you may be just starting to save for retirement, but by the time you retire you will have $ 500,000 or $ 1 million in your pension plan, so you won’t have maybe you don’t need that $ 500,000 life insurance policy anymore.
3. Income generator
Some prefer to aim to build up a large life insurance investment that would generate income to provide annual income to a beneficiary. For example, $ 1 million invested with a conservative average annual return of 4% could earn a spouse or family $ 40,000 per year in perpetuity.
“Although the need for life insurance is temporary for most dependents, there are exceptions, such as a child with special needs who will never be independent, where the need lasts the rest of their life,” explains Steuer, who is also the director of financial preparation for the insurance consumer group United Policyholders.
Daily says that while no single model is suitable for all families, everyone can benefit from one or more test drives.
“The advantage of looking to the future and not just the present is that you will have a sense of whether your insurance needs are increasing, decreasing, or staying roughly the same,” he says. “This is going to have some relevance to the type or combination of insurance you should be purchasing.”
Factors to Consider When Buying Life Insurance
You may be wondering “how much life insurance should I have?” »Consider these factors:
- Your age: Contribution rates generally increase with age. If you are young, term life insurance (covering a number of years) is generally considered the most cost effective way to cover your risks and keep your future life insurance options open.
- Age of spouse and children: This helps you estimate how many years of income replacement they will need if you were to die.
- Mortgage and debts: Include your mortgage, car loans, student loans, and other debt in your life insurance plan.
- College fees: Consider future education expenses for the children and perhaps your spouse. Tuition and fees for four-year colleges have increased by up to 5.2% on average.
- Your current income: If you’ve paid off your debt and set aside college funds, you may not need to replace all of your income. Some advisors recommend a 50% replacement as a starting point.
- Funeral expenses: The average cost of funeral, burial and related expenses exceeds $ 7,000, while the average cost of cremation ranges from $ 2,000 to $ 4,000. Do not stick the final invoice to your loved ones.
Sources: Etti Baranoff, Glenn Daily, Tony Steuer
Choose your life insurance contract
Once you hit a rough coverage figure, Steuer suggests letting your personal circumstances dictate whether to use a whole life (permanent) cash value policy, term life insurance, or a combination.
“One tactic I recommend is to separate planning for your spouse from planning for your children, as the timeframe for needing coverage may differ,” he says. “If you have a 15-year-old, you really only need a 10-year policy to follow the kid through college. But if you’re 45 and plan to work another 20 years, your non-working spouse will need at least a 20-year life insurance policy.
All three experts warn against siren song of cash-value life insurance products that promise big returns on your investment that you could reap while you’re still on this side of the lawn.
“This is one of the main reasons people buy too much,” says Steuer. “You want to eliminate all the distractors and meet your real need. Don’t expect something from your life insurance that you wouldn’t expect from other insurance policies.
Baranoff puts it even more succinctly: “Life insurance is for widows and orphans.
Frequently Asked Questions
What is the main difference between term life insurance and whole life insurance?
Term life insurance is purchased for a certain period of time, usually between 10 and 30 years. Whole life insurance does not have an end date like term life insurance. As long as you continue to pay your premiums and follow the carrier’s requirements, your policy should remain in force.
How Much Term Life Insurance Should I Buy?
Buying term life insurance is finding the right balance. Otherwise, you can under or overbuy the coverage. To decide on the best amount, Bankrate’s life insurance calculator can be helpful in figuring out what you need.
How to find the cheapest life insurance?
Many life insurance companies sell quality policies designed to meet your life insurance needs and fit within your current budget. To find the cheapest life insurance, get quotes from multiple insurers to compare. Make sure you compare similar products and the same amount to get the best (and cheapest) life insurance.