Here's How to Know if You Have the Right Amount of Life Insurance

How much life insurance do you need? Having too little puts your family at risk of not being able to maintain their lifestyle should something unexpected occur to you. 

Having too much life insurance means you’re overpaying and could be putting that money toward other investments or even early retirement. If you want to stop throwing away your money, then you need to be careful about over- or under-buying life insurance.

To know how much life insurance you actually need without overspending, consider these important factors.

Most likely, if you pass away, you’ll want plenty of life insurance funds available to pay off your existing debt. Otherwise, the assets in your estate will have to satisfy the debt.

To figure out how much life insurance you may need, calculate how much debt you have. If you pay off your debt, you’ll need less life insurance. If you don’t carry a significant amount of debt, don’t purchase additional coverage “just in case.”

Like other debt, your mortgage should be a primary driving force in determining how much life insurance you need. Most often, the life insurance funds can pay off your home, protecting this asset for your family. In addition to mortgage payments, consider leaving enough money to cover taxes and insurance for several years.

Your family is dependent on your income. Consider how many years’ worth of income you wish to leave behind to provide them with a financial buffer to meet their needs. Multiply your current salary by the number of years you want to provide replacement income for your beneficiaries. That could be five, 10, or more, depending on your goals. If you’re replacing more than 10 to 20 times what you are currently making, chances are good, that’s too much.

If you have minor children, providing funds to cover their expenses at least until they reach adulthood could be important to you. It’s a common reason parents purchase term life insurance policies.

Consider what would happen to your child if you were to pass away. Who would care for them? What are their financial needs in that situation? Estimate the amount of life insurance you need based on how much you feel is enough to meet their needs.

Look up the average cost of life insurance in your state. As you learn how to buy life insurance that fits your needs, consider if your child will go to college, where they may wish to go, and the cost of attending for four years. Build that amount into your policy if you hope to provide for these needs. Don’t add in children’s education costs if you don’t plan to pay for college out-of-pocket yourself.

You’ve decided to open a business or buy a second home. If you are considering adding on more debt or a high-risk venture, be sure your life insurance is adequate to cover those costs.

For example, it could take a few years for a business to become profitable. Should you die, your family may wish to carry on that business, and for that, they may need funds to do so. Estimate the annual expenses for the business or other financial investment above and beyond profits to ensure you include enough coverage.

One area many people fail to plan for is the end-of-life costs. Funeral costs are a component of that, but that’s not all to think about here. What if you leave behind a significant amount of medical debt? Your estate may have to pay to cover those costs, lowering the amount available for your family’s needs.

It’s impossible to know how much your family could need, but estimate based on much of your estate you wish to protect. By contrast, if you have burial or funeral expense insurance included in another component of your coverage, you don’t need to add this cost.

As you work through your life, you may build a valuable savings account and investment portfolio. As that value increases, you may not need to have as much life insurance to cover all of the costs listed so far. If you have a term life insurance policy that’s expiring, but you already have worked to build your savings to the level that you feel comfortable leaving behind, you may not want to renew your policy, especially at a higher cost.

You may have too much life insurance if you haven’t taken a look at all of your current benefits. A common oversight here is not realizing you may have a life insurance policy through your employer.

However, if this is supplemental life insurance, and you’re relying on it as your sole funding option, that could be a mistake, too. If you change jobs for any reason, that life insurance isn’t likely to go with you, meaning you’ll have nothing if you are laid off or fired.

Being realistic is a big part of choosing the best life insurance policy for your needs. There are simply some situations where you want to leave behind a significant amount of money to meet other priorities you have set. 

For some, that may include establishing a fund to support a school or a nonprofit organization. For others, it may mean leaving behind enough money to fund your estate plan, trusts for your grandchildren, and funds to care for your beloved animals. Extend your coverage when you need to do so to meet your financial goals.

Perhaps the biggest mistake you can make when it comes to life insurance coverage is not having any. If you’re unsure what to do with a tax refund this year, purchase a life insurance policy to provide financial protection for those dependent on you. Doing this helps to minimize the risks to them and could give you peace of mind.

Remember, too, that the younger and healthier you are when you buy life insurance, the more affordable the premiums will be. Don’t wait to secure your loved one’s financial future.