Financial Rules of Thumb: How Much Life Insurance Do You Need?

One of the less fun areas of financial planning is also one of the most important parts: protecting yourself against financial disasters with insurance. Life insurance is even more of a downer to consider because in order to have it pay off, someone has to actually die. Ugh.

But if you ask anyone who has loved ones whose lives would be drastically altered financially due to their death, you would be hard-pressed to find someone who would say they wouldn’t want to protect against that. That’s why life insurance is a necessary part of life for anyone who has financial dependents, whether that’s a spouse, kids, grandkids or in some cases, even employees. Yes, there are strategic ways to use life insurance to protect and increase large amounts of wealth, but the vast majority of people I speak to on our Financial Helpline simply want to make sure their family is protected in case of the unthinkable.

The big question is, how much do you need? The typical rule of thumb in the financial planning industry is 10-16 times your annual salary, so if you make $75,000 per year, you should have at least $750,000 in life insurance. For a more specific calculation, I also like to use LifeHappens.org. What it really boils down to is what you need the insurance to pay for should you be hit by the proverbial bus.

My parents always maintained enough insurance to at least pay off the mortgage so that the surviving parent would have a place to live no matter what. That was enough for them since both of my parents worked and either one’s income could pay the rest of their expenses. My husband and I took it a step further and purchased enough to pay off the mortgage plus put enough in the bank to pay for one college education. Taking it to the next level would be purchasing enough insurance so that if you invested it, it would pay enough interest, dividends or other income to replace your income. That can turn out to be a hefty amount, but it’s also the best way to make sure that your family wouldn’t have any financial concerns should you pass early.

Keep in mind that insurance will always be cheaper when you’re younger. In theory, you’ll be paying it longer so it all comes out in the wash! Don’t let someone talk you into a big policy just because it’s cheap if you don’t really have a need for it in the foreseeable future.

The second question to ask would be if you need the insurance only for a certain amount of time (like until the kids are grown) or if you want it to be in place your whole life. That’s the difference between the cheaper “term” insurance, which just goes away when the term is up, and the more expensive “whole” life insurance, which is intended to pay off no matter when you die. What you ultimately decide depends on your values and what you can afford. Some people simply don’t want to spend their money on a “Cadillac” insurance policy even if they have the money. Others may be limited by a pre-existing condition that makes their premiums super high, thus limiting how much coverage they can afford.

Finally, the different options available as far as the type of premium, length of time and other riders that can be attached is dizzying. There are countless insurance representatives out there who can help you, so find one who is willing and able to take the time to make sure you understand what you’re signing up for. Anyone who tries to rush you into a decision may not have your best interests at heart.

 

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