How to Think Through Your Life Insurance Needs
January 18, 2022
So, you know you need life insurance and you understand why it’s important. You want to protect your loved ones after you die with a death benefit that can provide them with funds for everyday expenses, and even some out-of-the-ordinary expenses as well. What you can’t quite figure out is how much life insurance coverage to buy—or what type of coverage is best for you. Ahead, a basic guide to help you determine the answers to those questions.
A common coverage rule of thumb.
Many experts recommend buying a policy with a death benefit that equals somewhere between 5 and 10 times your annual income. For instance, if you make $100,000 a year, you’d want $500,000 to $1 million in coverage to create financial security for your loved ones over many years. This benchmark is not a bad place to start. However, keep in mind that there are many considerations to make. Life insurance needs can vary widely on an individual basis.
Estimating your needs.
You can zero in on a more personalized estimate of your needs by considering the following factors:
- Your goals. Think about why you need life insurance. Would it simply be to cover your funeral expenses and pay off any outstanding debt? Or would you want it to make sure that your loved ones could maintain their lifestyle—stay in their home and even handle future costs, such as college education? Another thing to consider: Certain types of life insurance may better fit your goals. Permanent life insurance, for example, can provide not only lifelong protection, but access to an account value and other benefits that you may be able to use during your lifetime.
- Your financial situation. The lifestyle you want for your family is a crucial consideration. You’ll also want to think about:
- Do you have outstanding debt—mortgage, credit card balances, car loans, or student loans?
- Do you have children or other people (e.g., aging parents, a special-needs sibling) who depend on you financially?
- Do you have a partner or spouse who works, or does that person depend on your income?
- How many years do you want to replace your income to continue providing for your loved ones?
- How much savings can your family access if you die?
- Do you already have some amount of life insurance coverage?
- Time. How long would you need the coverage? For a specific period of time—until, say, until your kids are grown or your house is paid off? Or do you want your coverage to last for your entire life? This is important to consider because it can help you determine whether you’re looking for a term policy or a permanent policy, such as universal life or whole life.
- Price. The type of policy, and the amount of coverage you choose, will impact how much you pay. Your age and health also affects the cost. The younger you are when you purchase life insurance, the less expensive the policy. In fact, waiting until you are older to buy it increases the possibility of developing a medical issue that could raise your costs or even prevent your being approved for a policy at all.
Keeping in mind the general rule of thumb of 5 to 10 times your annual salary, you can get a ballpark estimate of your specific life insurance needs by doing some simple multiplication. For example, after considering the above factors, you might estimate that you need around 8 times your annual salary (or even more) to make sure your family is protected. From there, you’d seek out a policy with a death benefit for that amount. And if it’s something that makes sense for you, you’d find a policy that has any additional features you want.
Do the math.
If you’d like your estimate to be more precise, you can do more detailed calculations. (This is often referred to as a “needs analysis” or “needs assessment.”) For a basic needs analysis you would first estimate the immediate, ongoing, and future expenses you would want covered if you pass away. (These could include funeral costs, monthly mortgage and grocery bills, and future college costs for your children.) Then, add up all your outstanding debts, including your mortgage, credit card balances, student loans, and any personal loans. Then, consider other assets your loved ones can rely on, such as a surviving spouse’s income, your retirement savings, other savings and investment accounts, and so on. Finally, subtract these assets from the estimated debt and expenses. The difference will be the approximate amount of insurance coverage you need.
You can speak with an insurance or other financial professional to help you do this analysis. There are also free online calculators available.
You’re already on the right path
By reading this article, you are taking a step in the right direction. It’s a great exercise in coming up with the amount of life insurance coverage you need—and the peace of mind that results from taking care of your loved ones.
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