What's The Right Amount of Life Insurance for Me?
How to Calculate Your Your Life Insurance Needs
There are a lot of details to consider when you're getting life insurance for the first time. You have to think about who your life insurance beneficiary is, how long you'll need your life insurance for and exactly how much life insurance you can afford. All of this while considering your own mortality - it's heavy, we know.
Coverage amounts can vary widely between individuals, but there are common threads in how we calculate and decide upon what is the right amount of life insurance. If you think you're ready to take the plunge, but want to do a little more research first, take a look at these tips for how to choose a coverage amount.
Read on to learn more about the tools to help calculate what is the right amount of life insurance for your specific needs.
Contemplate your financial responsibilities.
Do you own a home? Are you working on paying back a substantial amount of student loan debt? Paying for private school for your kids? All of these financial responsibilities add up, and they are worth protecting. Figuring out the size of your duty is a helpful first step to deciding the amount of life insurance coverage you need.
How many years into the future will you be depended upon?
Since life insurance claims are often distributed to beneficiaries in a lump sum (though other options are available), you may want to calculate how far into the future your spouse, children or other dependents may require your assistance. This can include mortgage payments, living expenses and even college tuition. Once you have this figure, you'll be able to easier calculate how much coverage you'll need.
However, once you have dependents, you should buy enough life insurance so that, when combined with other sources of income, it will replace the income you now generate for them, plus enough to offset any additional expenses they will incur replacing services you currently provide (for example, if you do the taxes for your family, the survivors might have to hire a professional tax preparer).
Your family might also need extra money to make some changes after you die. For example, they might want to relocate, or your spouse might need to go back to school to be in a better position to help support the family.
Most families have some sources of post death income besides life insurance. The most common source is Social Security survivors' benefits. Many also have life insurance through an employer plan, and some from other affiliations, such as an association they belong to or a credit card. Although these sources might provide a significant income, it is rarely enough.
Don't forget your final send off.
It's easy to focus on those who might need you if you were to pass away, but don't forget to consider what funeral costs and medical expenses your dependents may need to take care of if you were to pass away. These expenses should factor into your final calculation.
Don't forget about term length.
Term length and coverage amount are undeniably connected. When asking yourself "how much life insurance can I afford," you may have to sacrifice on either term length or coverage amount in order to keep your rates manageable, knowing that you can review and renew your policy down the line. We all want cost-effective life insurance, but, of course, it may be hard to know what you can afford before you get your initial quote.
It's easy to see how the amount of life insurance coverage can vary from person to person. We don't all have a house, but, on the other hand, some of us have more than one. You may have one child, but someone else could have three. We all have different needs when we buy life insurance, but luckily, the questions we're faced with are relatively similar.
A Multiple of Salary?
Some experts recommend buying Term Life Insurance or Whole Life Insurance equal to 20 times your salary before taxes. If the benefit is invested in bonds that pay five percent interest, it would produce an amount equal to your salary at death, so the survivors could live off the interest and would not have to "invade" the principal.
While this formula is a useful starting point, it does not take inflation into account. It also assumes that one could assemble a portfolio that, after expenses, would provide a five percent interest stream every year. But assuming inflation is 3 percent per year, the purchasing power of a gross income of $50,000 would drop to about $38,300 in the 10th year.
To avoid this income drop off, the survivors would have to tap into the principal each year. And if they did, they would run out of money in the 16th year. The "multiple of salary" approach also ignores other sources of income, such as Social Security survivors' benefits. These benefits can be substantial.
Bottom line: the amount of life insurance you need varies according to your financial, family and marital circumstances, but once you have dependents, you probably need insurance coverage. If you are still asking "how much life insurance do I need?" it is probably best to seek the advice of a qualified insurance agent when you are ready to ask about getting a life insurance quote.