How To Figure Out What Amount Of Life Insurance You Need

August 15, 2017

Thinking about what would happen if you or your spouse were to pass away is tough — no one really wants to imagine the worst happening. The sad reality is that bad things sometimes happen to good people, so we need to be prepared, but you don’t want to spend too much on life insurance since there’s a strong chance you won’t need it. I encourage people to think of life insurance in terms of taking care of their loved ones rather than planning for something bad to happen.

Adequate life insurance can help your family maintain their home and lifestyle if you are not around. It could also give your kids a chance to graduate college without being saddled with thousands of dollars in student loans. But how much do you really need?

Choosing how much life insurance to buy can be confusing, but you want to know how much you need before you sit down with an agent so you can feel confident in your investment. Here are three of the more popular methods of figuring it out:

1. Multipliers of income: This one is pretty simple – you decide how much coverage you need based on how much you actually make each year. Keep in mind that it does not take into account inflation or your current and future financial obligations, just what life is like today. Here’s the rule of thumb:
   – If you are single with no dependents: enough to cover your burial expenses.
   – If you are married & your spouse earns a similar income: 5x your annual income.
   – If you are the primary income earner in your family: 10x your annual income.
2. Human life value: This method considers the fact that if you were to pass away, your family would lose the value of your income not only now, but your potential income in the future, then calculates what amount would be needed to replace that. There are calculators that can help determine what your amount may be based on your income and obligations, considering your after-tax pay while adjusting for expenses that would no longer exist if you passed away, such as a second car. Keep in mind, these amounts are typically high and may over-inflate how much you need. Think of this as the “Cadillac” value approach.
3. Needs analysis: No two people are the same and neither are their life insurance needs. This method basically says you should have enough insurance to cover certain things you value, such as paying off your mortgage or covering your child(ren)’s complete college education — someone else may choose to only have enough to cover 50% of their kids’ education or to only pay the mortgage for one year after they pass. Basically, the needs-based approach takes into account your personal situation to determine your insurance needs.

One great resource are the calculators on LifeHappens.org — my spouse and I both did this and boy was it an eye opener! It turns out that we had very different ideas on what we thought life insurance should cover, so it helped us to get on the same page about how much we should have, along with clarifying our expectations of what the life insurance would cover should one of us pass.

Out of all of the approaches, I like the the needs-based approach best because it takes into account exactly what you want to cover in order to give you a better picture of your needs. If you find that your life insurance needs are more than you currently have in place, take advantage of open enrollment season to increase your coverage at typically low group rates. You may also want to research rates with your home or auto insurance provider (sometimes they offer life insurance), your bank or even online.

No matter what, if you have a family or anyone who is dependent upon your income to fund their lifestyle, you need to have life insurance in place. There are too many stories out there about young families who are not only dealing with the unthinkable loss of a young parent, but also having to deal with the financial fall-out from a lack of insurance as well.

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