How Much Life Insurance Do I Need?

With so many options and coverage types, purchasing life insurance can feel overwhelming. After all, there are many factors you should probably take into account, such as the financial needs of any dependents, how long you need coverage for, what your budget is and what your health and lifestyle are like. Fortunately, Bankrate’s insurance experts demystify life insurance so you can start looking for the coverage you need for your financial goals.

What is life insurance?

Life insurance provides a tax-free financial payout to one or more beneficiaries of your choosing in the event of your death as long as your policy is in force at your time of death. Depending on the type of policy, life insurance will cover you for a specific amount of time — such as 10, 20 or 30 years — or can be designed to provide coverage for your entire life — up to age 95 to 121.

Who needs life insurance?

Life insurance can be a good idea for many people, not just those with children. Beneficiaries can also include business partners, siblings, ex-spouses or charities. It can even be used as collateral for loans, naming a lender a beneficiary.

People have many different needs for life insurance. For families, life insurance can provide income replacement and security. High-net-worth individuals might also benefit from life insurance for completely different reasons. For instance, you might purchase a policy in order to cover estate taxes or business succession planning. Because the reasons why people buy life insurance can vary so considerably, how much life insurance you should have also varies.

How much life insurance do I need?

A life insurance policy isn’t one-size-fits-all. Some of the individual factors that determine how much life insurance you need include:

• Your age
• The ages of your spouse and children
• Your income
• Your mortgage and other debts
• Assets and investments (which can reduce your life insurance need)
• Future major expenses for your children and/or spouse
• Burial costs and other final expenses

Before you take out a life insurance policy, consider what your goals are and what financial obligations would fall on someone else’s shoulders if you were to pass away unexpectedly.

If you don’t have dependents or they are self-sufficient, you might not need as much coverage, but you may want to pay for funeral expenses or leave a financial gift. Take time to consider what you want your insurance policy to accomplish before you determine the amount of coverage.

Example scenario: life insurance coverage for a family of four

If you’re married and have two children, you probably want your life insurance policy to be robust enough to cover the loss of your income and pay for significant financial obligations, like a mortgage or car payment. Additionally, life insurance could help pay for the substantial costs of raising children from infancy to adulthood and for their education.

If your children are quite young, consider a term policy with a term length of 20 or 30 years. This can ensure financial protection is there all through their growing years until they’re financially independent.

If your children are older, teenagers perhaps, a policy with a term length of 10 or 15 years may be sufficient.

If any of your children have a disability or special needs that will likely cause them to be dependent on you for their entire life, a permanent policy may be a better solution.

Securing life insurance can give your family peace of mind that you plan on providing for them in all situations.

Example scenario: life insurance coverage for a single individual

If you’re a single person who co-owns a business, you might use life insurance to financially protect the future of the company you built, your business partners and the employees who rely on you.

In this case, a life insurance policy can be used in a buy-sell agreement with your partner. In case of your early death, the policy can provide the funds necessary to keep the business running successfully.

A term policy that lasts until retirement may be sufficient. Permanent life insurance, however, is common with business needs as the cash value component can provide additional benefits and tax advantages.

Calculating your life insurance needs

There are several strategies that can help you figure out how much life insurance to purchase. You might choose to speak with a certified financial planner (CFP) or chartered life underwriter (CLU) who can assess your financial situation and make a recommendation based on your family’s potential needs. You can also use a free life insurance calculator to give you a general idea of how much coverage may be necessary for you.

Another option is to use one of the popular models devised by insurance companies and financial experts. Here are four common approaches that might help you pick a life insurance coverage limit:

1. The DIME Formula (and 10 Rule)

The old “how much life insurance do I need” rule of thumb was to take your income and multiply it by 10. This was the industry’s standard for many years. However, this fails to account for several things.

Most notably, it does not take into account your family’s living expenses. This could vary wildly if you have one child or four. Moreover, it does not account for single-income families.

As grim as it sounds, it’s important to ask yourself what would happen if you and your partner both die and only one has coverage? The 10 Rule left many questions unanswered. In its place came the DIME Formula, which takes into account the following:

• Debt and final expenses: Come up with a solid number based on all the debts you owe, and include the costs of final expenses for each parent.
• Income: For income, a good rule of thumb may be to think about how many years your family would need to become financially stable in your absence. Multiply the number of years by your annual income.
• Mortgage: Include the total amount owed on your mortgage and the property taxes assessed. Similar to income, think about how many years your family would need the money to cover property taxes, then multiply your annual tax total by those years.
• Education: Determine the total cost of educating each of your children through their remaining years of school, including college.

Once you come up with that final number, you might want to consider doubling that for both parents. That way, if something were to happen to both you and your partner, your children and other financially dependent family members would have sustainable income well into the future. Alternatively, each spouse could complete the DIME Formula independently for their own life insurance needs. One disadvantage to the DIME Formula is that it fails to consider inflation.

2. Shortfall calculation

The shortfall approach works backward from the annual income you would want to leave your spouse and family for X number of years. After you decide on this target number, subtract all other sources of annual income that will be available to them, such as your retirement accounts, pension, savings, your spouse’s salary and Social Security. The resulting number is the shortfall you’ll want to replace with life insurance.

When using this method, it’s also important to include all of your assets. If you’re starting to save for retirement, for example, you’ll likely have more assets in the future than you do right now. A life insurance policy may need to account for those future earnings as well.

3. The human life value approach

The human life value approach focuses on your income, retirement age, taxes, expenses and inflation. It essentially suggests that your life insurance coverage should equal how much you expect to earn during your lifetime. Unless you’re handy with a financial calculator, working with a financial advisor or chartered life underwriter may be helpful if you consider this approach.

4. The needs-based approach

This tends to be the most realistic calculation. Basically, the needs-based approach asks you to buy enough life insurance to provide for your family’s immediate financial needs, such as paying for a funeral, and ongoing standard of living costs.

For a rough estimate, add up the debts and expenses your family would shoulder if you passed away, then take your income and divide by a conservative interest rate. From these totals, subtract the funds your family would have access to, such as savings, retirement and investment accounts and any other life insurance coverage you may already own.

Keep in mind that the large amounts these calculations produce need special consideration as to what type of life insurance — term or permanent — should cover them. For large finite obligations, such as a mortgage and the cost of raising your children, term life insurance often makes the most sense. If you have lifelong insurance needs, such as covering estate taxes or inheritance equalization, then a permanent policy may be necessary.

Factors to consider when buying life insurance

Buying life insurance is a process that typically requires self-evaluation to build the right policy. Considering these factors may also help you narrow down how much life insurance you need:

• Your age: Life insurance premiums generally increase with age. Getting a life insurance policy while you’re young is typically more cost-effective in the long run.
• Age of spouse and children: This helps you estimate how many years of income replacement financial dependents would need if you passed away.
• Mortgage and debts: When choosing a life insurance coverage limit, you’ll likely want to account for your home mortgage, car loans, student loans and other debts in your decision. Most debt does not disappear when you pass away, so the responsibility would likely fall to your estate or any co-signers.
• College expenses: Educational expenses can be pricey. If you want to support your children and spouse through their future education, you’ll likely want to consider how many years of school they may pursue and the rising cost of education.
• Your current income: If you have no outstanding debt, no major future expenses (like college tuition) and have a healthy savings account, you may not need to replace your full income.
• Assets and investments: Savings, investments, existing life insurance and other income sources can be deducted from your total life insurance needs.
• Funeral expenses: The average cost for a burial or cremation, funeral and related expenses runs around $7,000. You may want to purchase enough life insurance to cover those end-of-life costs.

Choosing your life insurance policy

In addition to deciding how much coverage you need, you’ll also need to decide what type of life insurance is best for your needs. The two main types of life insurance are term life insurance and permanent life insurance. Under the umbrella of permanent life insurance, there are several different policy types, like whole life insurance and universal life insurance.

Term life insurance

Term insurance is just that — a life insurance policy that covers you for a set term or period of time. Most term policies are available for 10, 20 or 30 years, although you might find providers that offer shorter or longer terms. Term policies are typically the cheapest type of life insurance and rates are usually fixed for the entire term length.

Once the term is up, the policy expires unless you choose to renew the coverage or convert it to a permanent policy, if available. Note that utilizing either the renewing or converting option will increase the premium.

Permanent life insurance

Permanent life insurance can last your entire lifetime, as long as your policy remains in good standing. Since it is designed to provide coverage for your entire life under most circumstances, permanent life insurance typically has more expensive premiums. Note that although they’re considered lifetime policies, maximum coverage ages typically range from ages 95 to 121.

Most permanent life insurance products also has the advantage of cash value. As you make your premium payments, your cash value earns interest. Once enough funds have accumulated, you can borrow from this account in the form of interest-bearing policy loans. If you have a universal life policy, you can also opt for withdrawals.

While cash-value life insurance products do offer some benefits, returns may fluctuate depending on your policy type. Borrowing and withdrawing from the cash value can also impact the policy’s guarantees and death benefits. Permanent life insurance policies require monitoring to ensure that they perform as expected. It may be best to speak with a licensed insurance agent before purchasing a policy with a cash value component.

So, which policy is right for you? Your individual circumstances may provide the best guidance in dictating whether to choose a permanent policy, term insurance or a combination.

For example, families might prefer a term policy since it can cover large financial responsibilities that won’t last forever, such as college tuition or a mortgage, while permanent insurance might be a better fit for someone wanting to pay for end-of-life expenses or estate taxes.

The payouts from life insurance policies can be used in a number of ways by those you leave behind, whether to ensure business continuity or help your family pay the bills should you pass away unexpectedly. Work with an experienced licensed agent and get multiple life insurance quotes to find the best price, especially if you have any health concerns or pre-existing conditions.

Frequently asked questions

• Does everyone need life insurance?
  

  Not everyone necessarily needs a life insurance policy. If you have substantial savings, can cover end-of-life expenses and don’t have dependents who are relying on you financially, you might consider whether or not you truly need a policy. Before you make your decision, you might want to speak to a financial advisor.

• What is the difference between term and whole life insurance?
  

  The main difference between term life and whole life is the length of time you’re covered and the cost of coverage. Term life insurance provides coverage for a set period of time, typically between 10 and 30 years, and is often far less expensive than whole life. Whole life insurance is designed to last your whole life. As long as you keep paying your premiums and follow the carrier’s requirements, your whole life policy lasts until ages 95 to 121.

• Do I need life insurance riders?
  

  Life insurance riders could offer flexibility in personalizing your life insurance policy. If you’re wondering how to choose life insurance riders, consider starting by exploring the options different life insurance companies offer. From there, you could also speak with a licensed life insurance agent to determine which ones may help build the best life insurance policy for you and your family.

• Can you have more than one life insurance policy?
  

  Yes, you can have more than one life insurance policy. Purchasing multiple policies may be strategic, like in the case of laddering your life insurance (a process that involves stacking multiple term policies). However, before you purchase more than one life insurance policy, you may want to review the potential benefits and drawbacks of this strategy and speak to a licensed life insurance agent to see if it could be right for you.

• How do I find the cheapest life insurance?
  

  Many life insurance companies sell quality policies designed to meet your life insurance needs and fit your current budget. To find the cheapest life insurance, get quotes from several insurers to compare. Make sure you are comparing similar products and the same amount to get the best (and cheapest) life insurance. Note that a quote may or may not reflect your actual rate after your health and lifestyle are taken into consideration during the underwriting process.