Here’s How Much Life Insurance You Really Need

You know you need life insurance, but you just aren’t sure how much coverage you need. This article will help you figure that out.
Last updated Sep 12, 2020 | By Matt Miczulski
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If you’ve recently purchased life insurance or are considering taking out a life insurance policy, you may be wondering how much life insurance you need. This is one of the important life insurance questions and can be a stressful point in the process because, simply put, you want to be sure your family is taken care of in the event of your death.

We’ve got some guidance to help you figure out the amount of life insurance you need. But before we jump into that, let’s take a look at the two different types of life insurance.

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Term vs. permanent: the basics

Life insurance falls into two basic categories: term and permanent. Term life insurance is a type of life insurance that lasts a designated period of time, or term, usually between one and 30 years. Policyholders pay a premium for the coverage, and if the policyholder dies during the term, the life insurance company pays out a death benefit to the beneficiary listed on the policy.

Permanent life insurance, on the other hand, is a type of life insurance that lasts the duration of the insured’s life. When you die, whether that’s tomorrow or 50 years from now, your policy will pay out a death benefit to your life insurance beneficiary — as long as you continue paying the premium on your policy.

As you pay your premium, part of the payment is applied toward the cash value of your policy. The cash value is different from the face value amount — the amount of money that will be paid upon your death — and is available to you while you’re alive. Upon your death, and unless you have a specific rider that states otherwise, the cash value is surrendered and returned to the insurance company.

There are several ways you can use the cash value of your policy while you’re alive, though this can vary from policy to policy. Generally speaking, you can either surrender the policy before you die and collect the savings, make withdrawals, or take a loan from the insurance company and use the cash value as collateral. You may also be able to apply your cash savings toward your premium.

Permanent life is further broken down into four subcategories — traditional whole life, universal life, variable life, and variable universal life. Although each of these types of permanent life provides coverage for the duration of your life, they differ in terms of flexibility and how your cash value grows.

For instance, under a whole life insurance policy, the savings element grows based on the dividends your insurer pays you. Under a variable life policy, you can invest the cash value in stocks, bonds, and money market mutual funds. Although this can provide greater returns, there’s also more risk if your investments don’t perform well.

Between the two, term life is generally simpler and more affordable than permanent coverage. Exactly how much your policy will cost depends on a variety of factors, such as your age, gender, occupation, medical history, the medical history of your parents and siblings, and whether you smoke, among other things.

How much life insurance do I need?

After you’ve decided which is the best life insurance for you, you’ll need to determine how much life insurance you need. The amount of life insurance that’s right for you will vary based on your situation and individual needs.

For instance, a sole income earner with three young children will likely need more life insurance than a newlywed without children. In this situation, the sole income earner would want to purchase enough life insurance to replace the income that would be lost in the event of their death. However, a married couple without children, who both receive company-provided life insurance, may wonder whether purchasing additional life insurance is worth it. In short, it depends on your specific needs.

Trying to determine how much life insurance you need can feel tricky because you don’t know what the future holds, but there are some general rules of thumb that can help you determine an amount you feel is appropriate.

Here are two common ways to calculate how much life insurance you need:

The DIME method

DIME stands for debt, income, mortgage, and education. These are some of the biggest factors to consider when making an estimation of how much life insurance you need. Here’s how to estimate your insurance needs using the DIME method:

  • Debt: Total all your debts — aside from your mortgage — including credit cards, personal loans, student loans, car payments, etc. You should purchase enough life insurance to pay off all these bills in the event of your death. You may also want to include funeral expenses in this calculation. According to the National Funeral Directors Association, the median cost of a traditional funeral in 2019 was $7,640.
  • Income: A primary reason to purchase life insurance is to replace lost income in the event of the insured’s death. So how much do you make a year? What all does that income go toward? Food, clothing, childcare expenses? If you have children, consider how many years until your youngest child will no longer depend on your income. A good place to start is to multiply your income with the number of years until your youngest graduates from high school. For example, if you make $45,000 a year and have 14 years until your youngest child graduates high school, put down $630,000 for income.
  • Mortgage: In the event of your death, you want enough life insurance to pay off your mortgage. Mortgage payments are one of the largest expenses in most people’s budgets, and having a large enough policy to pay it off in full will provide your family with security and peace of mind as they navigate through tough times.
  • Education: Take into account how many children you have and any savings you already have in place that will go toward your children’s future college educations to help determine how much you need for education costs. According to the National Center for Education Statistics, the average cost of a college education for the 2016-17 academic year was $17,237 at public institutions and $44,551 for private nonprofit institutions. Multiply your choice by four years and by the number of children you have to get an estimate. For example, if you have three children and want to send them all to private nonprofit institutions, put down at least $535,000 for education.

After determining the costs for all four factors, add them up and that’s your number. Remember to account for any savings and life insurance you already have, as these will reduce the amount of additional life insurance you need.

10x method

Perhaps a more simplified approach, the 10x method is another way to help determine how much life insurance you need. Simply put, this common rule of thumb states that you should purchase enough life insurance to cover 10x your income.

As you can already tell, this method doesn’t require you to break down the costs as the DIME method does. Although this may seem like an easier approach, you really need to consider whether 10x your income is enough.

If we go back to the example in the income section of the DIME method, we calculated that amount by multiplying a hypothetical $45,000 annual salary by 14 years (the number of years until your youngest child graduates from high school). This is already well over 10x your income and doesn’t even account for your debt, mortgage, or the cost of sending your children to college.

The 10x method gives you a quick calculation, but a quick calculation is probably not the best way to determine how much life insurance coverage you need. It’s worth taking the time to figure out the details.

The bottom line on buying life insurance

Shopping for life insurance can be stressful, especially if you’re not sure how much life insurance you need. Once you decide which type of life insurance is best for you, you can really get into the weeds as to how much coverage you need.

Although the amount of life insurance needed can vary drastically from person to person, you can use the two rules of thumb detailed above to help you come up with an estimate. It’s worth running the numbers for each method to see which amount you feel will adequately cover your needs. Term life insurance is very affordable, so purchasing enough coverage shouldn’t break the bank. And it will give you peace of mind knowing your family will be taken care of if you pass away.

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