How Much Life Insurance You Need: Factors Not to Ignore

I know it's not fun to think about dying, but it's a fact of life and it's always best to prepare for the worst. That's why life insurance is essential for most people, but how much life insurance do you really need?

I always start with the basics, such as covering the mortgage and any essential expenses, but there's a lot more to consider. You may even want multiple policies to cover different situations. I've covered everything you need to consider when choosing your life insurance coverage below.

How much life insurance do I need?

Most people buy life insurance to ensure their loved ones' financial security upon their passing, but some buy life insurance for other reasons too. Understanding your reasons for wanting life insurance will help you determine how much life insurance you really need. For example, when we bought our first house, we had a large mortgage, so we wanted to be sure we had enough life insurance to cover the mortgage should one of us die unexpectedly so the surviving spouse wasn't left stranded.

Here are some other common scenarios you may consider:

• Replacing your income for surviving family members
• Paying for kids to go to college
• Covering a large mortgage debt
• Covering other large debts
• Covering your funeral costs
• Leaving behind a legacy

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 three common methods 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, and car payments and include the amount in your life insurance. Some people also include funeral expenses in the debt, which according to the National Funeral Directors Association, costs an average of $8,300 for a traditional funeral.
• Income: Multiply your annual income by the number of years you want to provide for your family if you die. Some people cover the number of years until their children turn 18, or until their spouse might retire. So if you make $100,000 a year and want to provide ten years of coverage, you'd need $1 million to provide adequate income.
• Mortgage: Consider including your outstanding mortgage balance in your insurance coverage to ensure your loved ones have some stability during their difficult times.
• Education: According to the National Center for Education Statistics, the average cost of a college education for the 2022-2023 academic year was $27,100 at public institutions and $58,600 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 institutions, put down at least $703,200 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

Some people use a more simplified approach called the 10x method. 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. In our example above, 10x your income would be $1 million, but if you have a $400,000 mortgage, and want to have enough for your three children to go to college, you've already exceeded $1 million.

This method also isn't accurate if you are a stay-at-home parent as there are many services the surviving spouse will have to cover (and pay for), such as childcare that would increase the surviving spouse's expenses.

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.

10x method plus $100,000

If you like the simplicity of the 10x method, you can use it with a twist. This works if you have kids you anticipate going to college. You get coverage for 10x your income, plus $100,000 per child for college education. This may not cover the full cost, especially if they go to a private institution, but it gives you a little more cushion if you don't want to get into the nitty gritty details of your liabilities, which again, I highly encourage you to do to ensure your loved ones have adequate protection.

Other tips to determine how much life insurance you need

The above methods are meant to be used as guidelines. They can give you a head start in determining how much life insurance you need, but you should consider the following factors as well:

• Savings: Life insurance is one piece of the puzzle in planning your estate and protecting your family. But, if you have adequate savings for things like college or to pay off the mortgage, you can reduce the amount of life insurance you purchase. However, if you don't have money saved, you may be better off insuring yourself more to protect your loved ones.
• Consider increasing income: Most people make more money as they age, whether through raises, side hustles, or changing careers. Take this into consideration when planning your insurance coverage. Basing your coverage on today's income may not be enough if your loved ones don't need the insurance for another ten years.
• Consider multiple policies: If you have specific debts or situations you purchase life insurance for, you may consider multiple policies; one for each situation. For example, you may take out a 20-year policy to cover your mortgage with 20 years left to repay, or a 10-year policy to cover any children that may attend college. This ensures the policies expire after you no longer need them.

Term vs. permanent: the basics

When deciding how much life insurance you need, you must choose between term and permanent life insurance.

Term life insurance

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

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.

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.

Bottom line

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 above guidelines 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. Remember, 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.