How Much Life Insurance Do I Need? - You
can’t pinpoint the ideal amount of life insurance you should buy down to the
penny. But you can make a sound estimate if you consider your current financial
situation and imagine what your loved ones will need in the coming years.
In
general, you should find your ideal life insurance policy amount by calculating
your long-term financial obligations and then subtracting your assets. The
remainder is the gap that life insurance will have to
fill. But it can be difficult to know what to include in your calculations, so
there are several widely circulated rules of thumb meant to help you decide the
right coverage amount. Here are a few of them.
Rule of thumb No. 1: Multiply your income by 10.
“It’s not a bad rule, but based on our economy
today and interest rates, it’s an outdated rule,” says Marvin Feldman,
president, and CEO of insurance industry
group Life Happens.
The “10 times income” rule doesn’t take a
detailed look at your family’s needs, nor does it take into account your
savings or existing life insurance policies. And it doesn’t provide a coverage
amount for stay-at-home parents.
Both parents should be insured, Feldman says.
That’s because the value provided by the stay-at-home parent needs to be
replaced if he or she dies. At a bare minimum, the remaining parent would have
to pay someone to provide the services, such as child care, that the
stay-at-home parent provided for free.
Rule of thumb No. 2: Buy 10 times your income,
plus $100,000 per child for college expenses
Education expenses are an important component of
your life insurance calculation if you have kids. This formula adds another
layer to the “10 times income” rule, but it still doesn’t take a deep look at
all of your family’s needs, assets or any life insurance coverage already in
place.
Rule of thumb No. 3: The DIME formula
This formula encourages you to take a more
detailed look at your finances than the other two. DIME stands for debt,
income, mortgage and education, four areas that you should consider when
calculating your life insurance needs.
Debt and final expenses: Add up your debts, other than your mortgage,
plus an estimate of your funeral expenses.
Income: Decide for how many years your family would need
support, and multiply your annual income by that number. The multiplier might
be the number of years before your youngest child graduates from high
school. Use this calculator to compute your income replacement needs:
Mortgage: Calculate the amount you need to pay off
your mortgage.
Education: Estimate the cost of sending your kids to
college.
The formula is more comprehensive, but it
doesn’t account for the life insurance coverage and savings you already have,
and it doesn’t consider the unpaid contributions a stay-at-home parent makes.
How to find your best number
Follow this general philosophy to find your own
target coverage amount: financial obligations minus liquid assets.
1.
Calculate obligations:
Add your annual salaries (times the
number of years that you want to replace income) + your mortgage balance + your
other debts + future needs such as college and funeral costs. If you’re a
stay-at-home parent, include the cost to replace the services that you provide,
such as childcare.
2.
From that, subtract
liquid assets such as savings + existing
college funds + current life insurance.
Tips to keep in mind
Keep these tips in mind as you calculate your
coverage needs:
·
Rather than planning
life insurance in isolation, consider the purchase as part of an overall
financial plan, says certified financial planner Andy Tilp, president of
Trillium Valley Financial Planning near Portland, Oregon. That plan should take
into account future expenses, such as college costs, and the future growth of
your income or assets. “Once that information is known, then you can map the
life insurance need on top of the plan,” he says.
» Learn more: Read about the differences between whole
life and term life insurance.
Don’t skimp. Feldman recommends buying a little
more coverage than you think you’ll need instead of buying less. Remember, your
income likely will rise over the years, and so will your expenses. While you
can’t anticipate exactly how much either of these will increase, a cushion
helps make sure your spouse and kids can maintain their lifestyle.
Consider buying multiple, smaller life insurance
policies, instead of one larger policy, to vary your coverage as your needs ebb
and flow.
·
Talk the numbers through
with your spouse, Feldman advises. How much money does your spouse think the
family would need to carry on without you? Do your estimates make sense to him
or her? For example, would your family need to replace your full income or just a portion?
·
Consider buying
multiple, smaller life insurance policies, instead of one larger policy, to
vary your coverage as your needs ebb and flow. “This can reduce total costs while ensuring adequate coverage to the
times needed,” Tilp says. For instance, you could buy a 30-year term policy to
cover your spouse until your retirement and a 20-year term policy to cover your
children until they graduate from college. Compare term
life insurance quotes to estimate costs.
·
Turner recommends
parents of young children choose 30-year versus 20-year terms to give them
plenty of time to build up assets. With a longer term, you’re less likely to
get caught short and have to shop for coverage again when you’re older and
rates are higher.
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