How Much Life Insurance Do I Need?
Andrew Dehan8-minute read
April 09, 2021
You know you need to invest in life insurance. It’s the best way to provide a safety net for your spouse, children or other beneficiaries. If you should die unexpectedly, your life insurance policy will provide an important cash payout to these loved ones.
But how much life insurance do you need? What type of policy, and for what amount, should you take out?
Not surprisingly, that’s a question that depends largely on your financial situation, the needs of your beneficiaries and the monthly expenses that your loved ones will face if you should die.
That said, there are some tips you can follow when trying to determine the amount of life insurance that’s right for you. And if you have questions about any personal finance topic, visit our Personal Finance Learning Center for tips on everything from saving money to building an emergency fund and crafting a strong credit score.
How Much Life Insurance Do You Really Need?
Fuad Sahouri Jr., vice president of McLean, Virginia-based Sahouri Insurance, says that there's no one-size-fits-all approach to life insurance. Every consumer has different needs. You need to consider these when determining how much coverage is right for you.
For instance, if your children are older and are generating their own incomes, you might not need as much life insurance. But if one of your children is differently abled and has limited earning potential, you might need more.
That said, there are some general guidelines that Sahouri advises. One of them is that you’ll want enough life insurance so that your spouse and children can remain in their home and enjoy the same type of lifestyle they’ve lived thanks to your financial support.
"That way, your family will not have to deal with an unexpected loss of income," Sahouri says.
But what if you don't have a family? Sahouri says that you might still want life insurance. If you die, your parents or other relatives might have to plan your burial and funeral. A life insurance policy can cover the costs associated with that. Even if you don't have a family, you might want to leave money behind for your parents or other relatives. A life insurance policy can help you do this, Sahouri says.
Sahouri says that people without a family who do want to leave something behind can start with a more modest policy, say a term-life policy that pays out $100,000 upon your death. As these people’s lives change, they can graduate to more valuable life insurance policies.
The Three P’s Of Life Insurance
According to a representative from life insurance comparison site QuickQuote.com, consumers should consider the three P’s when determining how much life insurance they need: purpose, payout and price.
First, look at the purpose of your life insurance policy. Are you the main breadwinner in the family? Do you still have young children living at home? Do you or your beneficiaries have large debts such as a mortgage or student loan?
If you answered "yes" to these questions, you might need a life insurance policy with a larger payout.
When considering the payout, advisors point to one industry standard that is especially useful for applicants with young children at home: Apply for a policy that is equal to 10 – 12 times your gross annual salary. If you make $50,000 a year, apply for a 20-year or 30-year term life policy with a face amount from $500,000 to $600,000.
You can adjust this down if your children are older and not as reliant on your income. You can boost it if you want your spouse to be able to pay off big debts if you should die unexpectedly.
Finally, price is the third big consideration. Term life insurance is typically cheaper and might be a better fit for consumers worried about monthly bills. Those consumers who want life insurance coverage for their entire lives, though, might be better off to purchase a whole life policy, even though it’s more expensive.
In essence, you can't determine how much insurance you need until you determine what you need it for, how much you currently earn and how much you're willing to spend or can afford to spend each month.
Calculating Your Life Insurance Needs
Bradford Lines, agency owner of Lines Insurance and Financial Services in Laurel, Maryland, says that too many consumers simply rely on round numbers when considering their life insurance needs, paying for coverage amounts of $250,000, $500,000 or $1 million.
This is a mistake. Consumers should instead take the time to calculate their true insurance needs, Lines says. The good news? Lines says performing a life insurance needs analysis can take as little as 10 – 15 minutes, and that most insurance carriers offer free online tools to help with this calculation.
"For a decision that can affect your family's future, 10 – 15 minutes of thought certainly seems worth it," Lines says.
What should you consider when performing this analysis? Your outstanding debts, such as mortgages, student loans and credit card bills, matter. So does income replacement: How much would your family need to continue its current lifestyle should your income stream disappear? Lines said that a common rule of thumb states that you should take out enough life insurance to cover 5 years of your annual income. If you make $100,000 a year, then, your life insurance policy should come with a payout of at least $500,000.
This amount could be higher, though. For instance, maybe you want your insurance policy to pay out enough to cover the future college expenses of your young children. You'd have to boost your coverage amount to meet this goal
When Value Isn’t Reflected By Income
A common situation, especially in multigenerational homes, is when value isn’t reflected by income. Let’s think through a fictional example where you’d want a policy that covers beyond just your income.
Mr. and Mrs. Ramirez are both entering their 60s and both work full-time. Their daughter and son are living with them while they attend school. Mrs. Ramirez’s mother, who’s in her 80s, has been living with them since her husband passed.
This is where income replacement should be factored in. If something were to happen to either of the income earners, things would be tight for the family. Mrs. Ramirez’s mother isn’t going back to work, so if income is lost, one or both of the kids may have to drop out of school to work.
Leslie Kasperowicz, a managing insurance editor at QuickQuote.com, says that “life insurance allows you to provide financial security that is tax-free and doesn’t have to go through probate. That means that the funds are available more quickly and easier to access than an inheritance.”
So, if one or both of the providers in the Ramirez family pass, with life insurance the family can receive immediate help.
Kasperowicz adds, “Because life insurance isn’t considered part of your estate, it can’t get wrapped up in any disputes and will go directly to the person for whom it is intended. Life insurance proceeds can be used for any purpose; there are no restrictions, and proceeds can be divided among multiple beneficiaries or left in trust for minor children.”
With a life insurance the policy, the Ramirez family can distribute the money as needed without a will. There’s more flexibility and that help arrives sooner.
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What Type Of Policy Is Best?
There are several types of life insurance policies. But the most affordable, and maybe the only type of policy you need, is term life insurance.
Term Life Insurance
Term policies provide life insurance for a specific number of years, usually 20 – 30. If you die during this time, your beneficiaries receive a payout from your insurer. You have the option to either renew your policy after the term ends or let it expire if you no longer need it.
Whole Life Insurance
A whole life insurance policy remains in effect for your entire life. It’s also an investment vehicle, designed to increase in value. Because of these factors, the premiums for whole life policies are more expensive.
Many financial advisors recommend taking out term life. First, the policies are less expensive. Second, you might not need life insurance for your entire life. Once your children are grown, they won't need your life insurance payout. And if you hit retirement with enough savings, you might not need a life insurance policy for your spouse, either.
Finally, there are other, less expensive ways to invest your money than in a whole life policy.
Insurance riders are extra items you can add-on to your life insurance policy to customize it to your situation. Some common life insurance riders include:
- Accidental death rider: For the scenario where the insured dies suddenly from an accident.
- Family income rider: If the insured dies, the life insurance company will provide a set income for a set number of years to the family. The amount and years are determined by the insured.
- Long-term care rider: This rider pays out if the insured receives at-home care or stays in a nursing home.
- Guaranteed insurability rider: If you need to purchase more coverage, a guaranteed insurability rider lets you do that without having to jump through loopholes. This is mostly used when you encounter large life changes, like an increase in income, a new child or the decline of the insured’s health.
There are many other types of riders. Just know that, the more coverage they offer, the more money you will likely have to pay for them.
Budgeting For Life Insurance Premiums
Manny Corallo, financial services representative from Barnum Financial Group in Shelton, Connecticut, says that while it's important to purchase enough life insurance, you must be realistic, too. Don't purchase a life insurance policy that comes with monthly premiums that won't fit into your household budget, he advises.
"A client also needs to be able to afford making the premium payments," Corallo says. "It is never a good idea to get in over your head trying to pay for something that is too costly."
Corallo says there are affordable options for life insurance, though, notably in the form of term life policies. It also makes sense to apply for life insurance when you’re younger. Premiums are less expensive when you’re younger and healthier.
You can reduce your premium, too, by cutting out unhealthy habits such as drinking or smoking and by losing weight.
The key is to make sure that if you should die, you'll have enough life insurance that your beneficiaries won't have to worry about their finances. Often that will mean that a basic insurance policy provided by an employer isn't enough.
"I personally find that people are many times under-insured," Corallo says. "They might think they're all set, but having a term policy from one's job does not mean the client and family are properly covered."
Reassess Your Needs Every Few Years
Just because you’ve hit upon the right life insurance formula in your 20s or 30s, doesn’t mean that you won’t have to tweak your coverage when you hit your 40s or 50s. As your life changes, so will your life insurance needs. Because of this, you’ll need to recalculate the amount you need throughout your life.
For instance, if your income increases significantly over time and you don’t adjust your family income rider, if you pass away, your family may not have enough to meet expenses. Similarly, as you get older, adding something like a long-term care rider or a rider that covers you makes more sense.
"One of the biggest mistakes people make with life insurance is buying it once and assuming that the decision is good forever," Lines says. "Just like any other insurance policy, your life insurance should be reassessed a minimum of every 3 – 5 years."
The Bottom Line
How much life insurance you need depends on your circumstances. Remember the 3 P’s of life insurance: Purchase, payout and price. Calculate how much life insurance you need and weigh your options. Learn about different types of life insurance, as well as riders you can choose. As you get older and your life changes, consider updating your life insurance policy.
Life insurance may not be the right option for everyone. But if you have dependents or a partner who would be financially impacted by your death, you should consider it. With life insurance there’s a sense of peace of mind knowing that your loved ones will have help when you’re gone.
Looking for the right life insurance? Read our article on how to shop for life insurance.
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