How Much Life Insurance Do You Need?
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 Rocket HQSM’s 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 Is Right For You?
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 disabled and has limited earning potential, you might need more.
That said, there are some general guidelines that Sahouri advises. And one of them? 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.
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
Schimri Yoyo, a licensed life insurance agent and financial advisor with Seattle-based CompareLifeInsurance.com, says that 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, Yoyo says. 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, Yoyo points 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. Yoyo says that term life insurance is 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.
Yoyo's takeaway? 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.
"These three P’s sort of have a cause-and-effect nature to them in that the purpose for the purchase of life insurance will highly influence the amount of payout you’ll look to pass on to your beneficiaries, which will highly influence the price to you for whichever product you choose," Yoyo says.
A Life Insurance Assessment
Bradford Lines, agency owner 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 to 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.
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 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.
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.
But 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.
Life Insurance Premiums Matter, Too
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."
And Finally … One Life Insurance Calculation A Lifetime Isn’t Enough
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.
"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."
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