How Much Life Insurance Do You Really Need?

When my wife and I first had children, one of the big questions I asked was a familiar one: How much life insurance do I need? While nobody likes to think of their own demise, it’s prudent to consider what financial ramifications your death could have on those you leave behind. It gives me tremendous peace of mind to know that if I die, my wife will have enough to pay off all our debts and take care of our family. While it’s hard to dispute the sensibility of life insurance in general, many people disagree on how much life insurance you should have. So if you are asking How much life insurance should I buy, here are some things to consider.

1. Rule of Thumb

When it comes to buying life insurance, there are some rules of thumb to help you determine how much you need. While no rule of thumb should be followed blindly, they can represent a good starting point for further analysis. So here are several widely used rules of thumb when it comes to buying life insurance:

  • 17 times salary: Take your annual salary and multiply by 17. So if you make $75,000 a year, with this approach, you’d buy $1,275,000 in life insurance. With this amount of life insurance, your beneficiary should be able to replace your income with interest and dividends earned from investing the life insurance proceeds. In effect, the 17 times salary rule of thumb is an income replacement for life model.
  • Sliding Scale: Some refine the multiplier based on your age. The younger you are, the higher the multiplier. For example, a 20-something would multiply their annual salary by 20, while somebody nearing retirement would multiple their income by just 5.
  • 5 to 10 times salary: If you are not looking to replace your salary for life, many suggestion 5 to 10 times salary. The idea with this rule of thumb is to help your loved ones pay off debt and to have some time to grieve without the added stress of financial worry.

2. What can you afford?

Regardless of how much coverage you need, think you need, or someone says you need, a critical financial consideration is how much life insurance you can afford. Exceeding a balanced budget isn’t in keeping with sound financial planning, no matter the line item. Admittedly, adjusting your spending in other areas to increase the premium you can afford may be prudent. Bottom line: don’t ask your family to live like paupers now so that, in the eventuality of your death, they can live like kings.

Make this your first order of business. This will help you to explore your maximum coverage without being stressed or tempted to buy more than you can afford. Find your maximum monthly payment, and stick to it as you seek quotes.

3. What is your minimum coverage?

None of us would mind making our family comfortable for the rest of their days. But before we tally up a $10,000 payoff for every second cousin, let’s consider the bare minimums needed. Typically, the most important factor people consider is liabilities. Is there a car payment? A home mortgage? A serious desire to provide for your child’s college education? Evaluate what debts and costs your family will have to face without you. Burial costs are another expense to consider.

4. What do you want to accomplish?

The bulk of your baseline coverage amounts should be dictated by your minimum coverage requirements you just tallied, but there are those who do want a considerable amount more than what will meet their family’s financial obligations. Many people evaluate what it would take to enable their grieving spouse to mourn for a year or two before returning to work. Others want to replace their income for life, so that a spouse never has to return to work. Again, this depends almost completely on your individual lifestyle. So give thought to what you’ll want the money to cover over and above paying off your debt.

5. Rules of thumb revisited

As described above, most rules of thumb for life insurance involve multiples of your salary. If you’re looking for minimum coverage, I’d say stick with the tally of your basic liabilities and goals. This will be more realistic and likely more affordable than blindly following a rule of thumb. However, if you ARE looking for your family to continue receiving the equivalent of your monthly paycheck for x number of years, then a multiple of your salary is a good approach to choosing the amount of life insurance to buy.

6. Don’t forget about terms!

I’ve made the assumption that your search for life insurance will likely bring you to the conclusion that term life insurance will meet your needs. To get a sense for the differences in life insurance (term, whole, permanent), check out our article discussing permanent life insurance.

At the same time you’re deciding on how many dollars of coverage you’ll need, you’ll also be faced with the question of how many years you’ll need the coverage. Ultimately, most financial gurus advocate self-insuring during the latter half of your life. Self-insuring simply means that you have enough money and assets to achieve the same financial goals you have identified above.

Summary:

  • In the event of calamity, some life insurance is better than none. Don’t put off the decision.
  • You can always layer coverage using multiple policies, meaning if you didn’t buy enough coverage the first time, you can get additional coverage through another policy.
  • People joke that you want to have enough coverage to make your spouse comfortable, but not enough to make them too comfortable with the idea of living without you. There might be something to that.
  • Perks and rewards are obviously secondary to premium amounts and coverage, but different insurers offer different benefits and features. Check to see if you receive any premium back at the end of your term, additional accidental death payouts, and terminal illness payouts.

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Published or Updated: April 3, 2014
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. I actually appreciate this post. I hate life insurance. Why? Definitely not because of what it is, but how confusing it is. It’s like I almost think our kids should be taught how insurance works in high school. I was so lost when I bought my first policy. All the in’s and out’s get rather confusing. I do like this post for the points it identifies.

  2. I am in the process of researching this right now. No fun at all, but thanks for the article Going to take your points into consideration.

  3. James says:

    I appreciate your sharing the discussion and identifying rules of thumb. What I find interesting about all of the articles discussing “how much life insurance do I need” that it is always focused on the “needs” and not the “wants”.

    As Mark III above mentions, Life Insurance can be confusing. It is really important to discuss not only what your loved one’s financial needs are but to delve more deeply into a discussion about what you “want” to accomplish.

    Insure the kids go to college.
    Insure the remaining spouse can hire help to take care of the kids.
    Insure that you can take time off work to grieve.
    Insure that the mortgage payments will be made.

    And that doesn’t even consider the more advanced reasons for buying life insurance:
    Creating a legacy.
    Reducing the size of your estate to legally reduce estate taxes.
    Providing cash to pay for estate taxes without having to sell appreciated assets.
    And the list goes on…

    Thanks again for providing the forum and emphasizing Point #4 from above. “What do you want to accomplish?”

    James

    **********
    California Term Life Insurance

  4. Shopping and buying life insurance can be confusing, there’s no doubt about it. The first thing to know is that there are 3 different types to research – term, whole and universal. Term is by far the cheapest but it has a limited term. Couples often buy this coverage when they buy a home. If you can obtain life insurance from your company, that is also a good idea that will makes things easier although they often have coverage limits. They might not even require a physical whereas if you apply for life insurance most companies will now require a physical.

  5. Joe says:

    Deciding how much life insurance your going to purchase should be thought out. If you have a financial advisor you currently work with chances are they have already talked about life insurance policies. There are several types of coverage to choose from but it’s important for consumers to remember that life insurance prices vary significantly between term, whole and universal coverage.

  6. Sandy Aubrey says:

    Not only is it important to have insurance, but also have payout structured to the correct person/entity so that it is immune from potential judgments after death, so the money goes only where you want it to go. Asset protection is as important as in life as in death.

  7. Rob Drury says:

    I’m reading all the comments above about how confusing, frustrating, etc. shopping for life insurance can be. That’s probably because the one doing the shopping isn’t qualified. Bypass surgery is tough when you try to do it on yourself; it goes a lot easier when a cardiac surgeon does it for you. Financial planning should be done by a financial planner. Life insurance decisions should be determined according to a comprehensive plan, with each element complementing the others. Most advisors will perform these basic functions at little or no cost.

    Rob Drury
    Executive Director,
    Association of Christian Financial Advisors

  8. Jerry says:

    This is a good and informative article but keep in mind that the years go by faster than you think. Buying a Whole Life or Universal Life Policy when you are young costs very little and the insurance is with you FOR LIFE if you keep paying on it. All too often we develop health problems (or age) that either causes us to be uninsurable –or we can only get insurance at a very high rate. Don’t let that happen to you.

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