How Much Life Insurance Do I Need?
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You want to do the right thing and get life insurance to provide for your loved ones. But how much life insurance will it take to do the job?
Ideally, you should have enough life insurance to replace the financial support you've been providing your loved ones for as long as they'll need it. That could mean working a job or it could mean taking care of the family. This article will show you a few possibilities for how to figure out how much life insurance is right for you.
How Do I Determine the Amount of Life Insurance I Need?
There's no shortage of rules of thumb, formulas and calculators you can use to figure out how much life insurance you need. That's kind of a mixed blessing, because no one approach is right for everyone's needs.
It helps if you understand enough about the various choices to see how well they apply to your situation. So, below is a run-through of some common methods for determining how much life insurance you need.
Multiple of income
A simple rule of thumb is to multiply your income by seven to 10 to arrive at how much life insurance you should buy.
This is a good rule if you want a quick answer and your financial situation is fairly simple. However, it doesn't allow for a lot of details about your life that may greatly affect your family's future needs. These include the amount of debt you have, your career potential and future spending needs.
Income plus financial obligations
If you have debt, multiply your income by seven to 10 times and subtract from that any debt balances that need to be paid off.
Financial obligations minus assets
Another way to look at the problem is to think in terms of what it would take to cover the difference between your financial obligations and any assets you've built up.
As a simple example, if you have a $100,000 mortgage balance and a $10,000 savings account, a $90,000 life insurance policy could cover the difference.
This approach may be too simple unless you think of financial obligations broadly as including not just your debts, but also the support you would like to provide for your family in the future - living expenses after you've gone, and possibly educational costs for your kids, maybe grandkids.
It's also very important to make a distinction between liquid assets like a savings account and long-term assets like a house.
It's easy to use liquid assets to pay off debt or cover living expenses. A house can't be used as readily for other financial needs unless you sell it or borrow against home equity.
The DIME formula
A common approach that tries to cover a number of bases used in the approaches already described is the DIME formula.
The acronym DIME stands for:
Debt plus final expenses. This is to make sure there's enough money to pay off any debt you have, plus any expenses associated with your death like a funeral.
Income times years. This would multiply your income by the number of years into the future for which your family would need financial support.
Mortgage balance. This is to make sure your most important (and possibly biggest) debt can be paid off - the one that affects shelter for your family. Since this is debt it probably could have been included in the first category, but then the acronym would be "DIE" which may be a little too on the nose.
Education. If college is in your kids' future, this expense will be far above normal living expenses. Covering that would require an additional amount of life insurance.
What Other Factors Affect How Much Life Insurance You Need?
Like trying to estimate how much money you'll need to retire, determining life insurance needs is not an exact science. However, any one of the methods described above is a step in the right direction.
Your estimate can be more accurate if you account for some additional details. The following are some other factors to consider when figuring out how much life insurance you'll need:
Childcare. If your surviving spouse suddenly becomes a single parent, your insurance may need to do more than replace your income. It may also have to provide for the cost of childcare so the surviving spouse can work.
Number of children. This can multiply your family's future expenses, especially if college is in the picture someday.
Age of kids. There's a big difference between the future expenses you'd have to provide for a newborn as opposed to for a child who is already grown up and self-supporting.
Long-term dependents. If you have a special needs child who will depend on your financial support into adulthood, or elderly parents who you're helping financially, you may need additional life insurance coverage.
Expenses vs. income. While income is often used as a basis for calculating insurance needs, actual living expenses may be more accurate. People who regularly borrow to make ends meet will need more insurance to cover future expenses. On the other hand, those who save a large chunk of their income would not need to replace all of that income to cover expenses.
Spouse's earning potential. The more future expenses your surviving spouse could cover, the less insurance you need.
Legacy. If you'd like to leave something to charity or a business you leave behind, you may want some insurance besides what you need to provide for your family.
What Happens If I Don't Get Enough Coverage?
Simply put, if you die without enough insurance it's likely to create financial hardships for your family.
They will face a tough choice between lowering their standard of living or figuring out a way to earn more money.
If this involves moving to cheaper housing, it could also force your kids to change schools. That would add to their upheaval at a sensitive time.
What Is the Minimum Amount of Life Insurance I Can Get?
You can get a life insurance policy for as little as $1,000. Of course, an amount like that wouldn't even cover funeral expenses, let alone provide for your family.
One of the things you should be clear on before you buy life insurance is what you want it to accomplish. If your goal is simply to cover funeral costs or pay off a specific debt, there may be a point to having a life insurance policy with a death benefit as low as $5,000 to $10,000.
However, if you want to provide meaningful financial support to your family you'll have to aim higher, using one of the methods for estimating life insurance needs discussed earlier in this article.
What If I Can't Afford the Life Insurance Coverage I Need?
You might run through an estimate of how much life insurance you need and find you can't afford it. What then?
Here are some steps you can take to work towards affording the life insurance coverage you need:
Start with what you can. Something is always better than nothing. If you can't afford the full amount of life insurance coverage you need now, you can always add coverage to build up to it later. In the meantime, get the coverage you can afford so your loved ones won't be left with nothing at all.
Choose term instead of permanent life insurance.Term policies only apply for a set number of years but they are much cheaper than permanent life insurance policies. That means a term policy can be an affordable way to get life insurance coverage initially. As your income grows, you may be better able to afford permanent life insurance later on.
Look into decreasing term life insurance. If even an ordinary term life insurance policy is beyond your means, something called decreasing term life insurance might work as a temporary stopgap. With a decreasing term policy, the death benefit declines each year. This makes the premiums more affordable. While that may give you less coverage than you need after a few years, by then your income may have improved enough for you to step up to a regular term policy or even a permanent one.
Shop around for better rates. Life insurance premiums can differ widely from one company to the next. Shop around before you commit to a policy. If you don't like the first quote you see, chances are there's a better one out there for you.
Get the Right Amount of Life Insurance at the Right Price
Providing for a family is a big job. It takes hard work when you're alive, so it should be no surprise that it would take a substantial amount of life insurance coverage if you should pass away.
Don't add to the burden by overpaying for life insurance. Shopping around can help you afford the coverage you need. Just enter your zip code in the space below to start the process of getting competing free quotes.