Pas Trusted News – How Much Life Insurance Do I Need?

Key points

  • Personal financial factors such as your income and debt will impact how much life insurance you need.
  • The type of life insurance you want and your financial goals will also affect how much life insurance coverage you should buy.
  • There are multiple calculations to estimate how much life insurance coverage to buy, including the DIME Method.

Life insurance is not one-size-fits-all and everyone will have different coverage needs. But there are a few key factors that can help you purchase the right amount of life insurance. We’ll help you identify those factors and provide some tips to help you determine how much life insurance you should have.

7 factors to consider when buying life insurance

Life insurance pays out a death benefit to your beneficiaries after you die. This money can be put toward investments, paying off debts, everyday expenses, education costs or virtually anything else your life insurance beneficiaries have in mind.

The best life insurance coverage amount often comes down to your unique needs and those of any dependents. That’s why it’s important to look at your full financial picture when making this decision.

The factors below offer a good starting point when determining your life insurance coverage needs:

  1. Your annual salary and how many years you’d like to replace your income for your family.
  2. Mortgage balance, specifically how much it would cost for your family to pay it off.
  3. Other debts you’d like paid off immediately, such as credit card debt or a student loan that won’t discharge upon your death.
  4. School tuition payments if you intend to cover those expenses for one or more children.
  5. Existing life insurance coverage, if any. Keep in mind supplemental life insurance coverage through an employer will likely end if you leave for another position.
  6. Assets your family can rely on, such as funds in a savings or investment account.
  7. If you own a business you can use life insurance to leave funds for your life insurance beneficiaries to handle business needs after you die (pay off debts, close the business down or keep it running).

According to Michael Demkiw, president and founder of Third Tier Wealth, “If you own a business, that has to also be considered, as well as when you anticipate retiring and what you will be receiving in Social Security payments. With all of these variables, people often need expert guidance when shopping for life insurance.”

Explore life insurance:

How to calculate how much life insurance you need

There are a few ways to determine how much life insurance you need. Most of them revolve around calculating your current and future debts and expenses. It’s important to be thorough when tallying up these figures to avoid being under- or over-insured.

Overestimating your needs can lead to unnecessarily high life insurance premiums. Underestimating your needs can leave a life insurance coverage gap that you’d need to address at a later date — and that could be costly.

As Priya Malani, the founder and CEO of Stash Wealth explained, “The main risk in adding coverage down the road is that it will likely cost more. The underwriting process, which determines how much the insurance will cost you, evaluates your current and past health. Presumably, as you get older, you run the risk that your health deteriorates which makes life insurance more expensive.”

Here are some popular methods for calculating how much life insurance you need.

Income multiplied by 10

Also referred to as the life insurance “rule of thumb,” this is an easy way to determine your life insurance coverage needs. Simply multiply your annual income by 10 for a baseline estimate of how much of a death benefit your life insurance beneficiaries would need. For instance, if your annual income is $80,000, your coverage need would be $800,000.

Annual income x 10 = Life insurance coverage

Though this approach is simple, it can leave gaps in coverage, especially when you factor in financial needs like tuition, mortgage payments, end-of-life expenses and other debts. Likewise, this method can leave you over-insured. For instance, if you don’t have any dependents or don’t have or plan to take out a mortgage, you may not need that much coverage.

DIME method

Another common approach to calculating life insurance needs is known as the DIME method, which stands for

  • Total (D)ebt.
  • Annual (I)ncome, multiplied by the number of years you want to replace it.
  • Remaining (M)ortgage balance.
  • Anticipated (E)ducation expenses for each child.

This straightforward method simply calls for adding up all four of those categories to determine your approximate life insurance need.

Debt + (Income x Years) + Mortgage balance + Educational expenses = Life insurance coverage

Obligations and earnings method

Another approach to figuring out how much life insurance you need is the “obligations minus earnings” method. This calculation involves adding:

  • Annual income (multiplied by the number of years you want to replace it).
  • Financial obligations, such as a mortgage, college tuition and loans.

Once you have that number, add up your:

  • Savings.
  • Accessible assets beneficiaries can use.
  • Other existing life insurance policies.

Subtract your earnings/assets number from your obligations to get an estimate of how much life insurance you need.

Financial obligationsEarnings/assets = Life insurance coverage

How does life insurance work and why do you need it?

When you purchase life insurance, you enter into a legal agreement with the insurer. In exchange for a premium payment — often monthly — the life insurance company will issue a death benefit payout when you die. The individual or multiple people who receive the death benefit are known as your beneficiaries, though an entity, such as a charitable organization, can also be designated a life insurance beneficiary.

You may need life insurance to pay off remaining debts, like a mortgage, after you die. Life insurance can also cover funeral expenses, college tuition and more to make sure your loved ones are financially protected after you’re gone.

There are multiple types of life insurance available, but they can be broken down into two primary categories: Term life insurance and permanent life insurance.

Term life insurance

Term life insurance is coverage that is set for a specific period, or term. During the term, such as 20 or 30 years, your rate and death benefit are locked in. If you die during the term, your beneficiaries receive a death benefit.

Some term life insurance policies give you the option to renew, typically at a higher rate, but will otherwise expire at the end of the term. If the policy is not active when you die, your beneficiaries will not receive a death benefit. Always check your policy or ask your insurer what happens at the end of the term.

If you have a term life insurance policy that is about to expire, you can extend coverage in three ways:

  • Renew the term life insurance policy, if this is an option — you may have to renew within a certain window.
  • Purchase a new life insurance policy, though likely for a higher premium because you will be older than when you purchased the original term life insurance policy.
  • Convert your policy to permanent life insurance, though that’s not always an option.

Permanent life insurance

Permanent life insurance refers to a life insurance policy that lasts a lifetime or to an advanced age, such as 100 years old. Once you purchase it, the policy will remain in effect as long as your premiums are paid.

Permanent life insurance also usually includes a cash value component, or an account that can grow over the life of your policy. Once enough money accumulates in the cash value account, you can borrow or make withdrawals against it. You may also be able to use the cash value to cover your premium payments.

There are multiple types of permanent life insurance, including:

  • Whole life insurance.
  • Universal life insurance.
  • Indexed universal life insurance.
  • Variable universal life insurance.
  • Guaranteed universal life insurance.
  • Burial or funeral insurance.

Learn more about the types of life insurance

Life insurance ratings

How much life insurance do you need FAQs

Yes, you can use a cash value life insurance policy as an investment, but it may not be the best option. Generally, you should consider leveraging other investment vehicles, such as annuities, IRAs or qualified retirement plans, such as a 401(k).

When you use life insurance as an investment vehicle, you have to also factor in surrender charges, management fees, annual fees, etc., on top of the cost of life insurance coverage. In addition, even though your cash value will likely grow over time, it typically reverts back to the insurer upon your death — it won’t pass on to your life insurance beneficiaries.

Though a $500,000 life insurance policy may be enough for some people, it won’t be enough for everyone. You should purchase a life insurance policy that meets your financial goals.

For instance, if you make $100,000 a year and want to replace your income for five years after your death, then a $500,000 policy may be enough. If you want to replace your income and pay off a mortgage or cover a child’s tuition, then $500,000 may not be adequate for your goals.

It may be possible to get money back after canceling a life insurance policy, but it depends on a variety of factors, including the type of life insurance, the insurer and your policy specifics, such as any life insurance riders.

In general, it’s less likely you’ll receive cash back from a term life insurance policy. Though you may be able to purchase a “return of premium” rider, which stipulates that the insurer returns your premium if you outlive your policy, it doesn’t always include cancellations. If it does, you may receive a reduced amount.

If you have a permanent life insurance policy with a cash value component, you can surrender the policy, which cancels coverage. In this case, you’ll usually receive the cash value of your policy minus any fees, charges or outstanding loan balances.

The life insurance rule of thumb is a method used to determine the amount of coverage you need. To use this method, simply multiply your current salary by 10.

For instance, if your salary is $100,000 annually, the rule of thumb suggests that a $1,000,000 life insurance policy will provide enough coverage. However, keep in mind that this method does not factor in other key financial considerations, such as mortgage payments, academic expenses, debts or other income streams or assets outside of your salary. It also does not account for inflation.

The DIME method is one of the best ways to calculate your life insurance needs. To use this method, add up the following:

  • Debt you want covered by a life insurance payout. 
  • Income (annual) multiplied by the number of years you want to replace it. 
  • Mortgage balance.
  • Educational expenses.

Other common ways to estimate life insurance needs include:

  • Multiplying your annual income by 10.
  • Adding up your expenses and any salary you want to replace and subtracting it from any assets or earnings your life insurance beneficiary will have access to.
  • Using a life insurance calculator.

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