How Much Life Insurance Do I 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.

But how much life insurance do you need? What type of policy, and for what amount, should you take out?

Not surprisingly, the answer 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.

What Is Life Insurance?

Life insurance is a contract you agree to with an insurance company where you pay into a policy and the insurer promises to pay out a certain amount if the insured passes away due to a covered reason. Plus, the amount of money will only be paid to the beneficiaries if the life insurance premiums are paid and up to date.

The aim of a life insurance policy is to financially protect loved ones after a death has occurred. For instance, if the insured was the breadwinner of a family, the insurance payout can help provide income for necessities for the beneficiaries. 

Life insurance policies can vary depending on the insurance company, and people have the option to get term or whole life insurance.

How Much Life Insurance Should I Have?

When determining how much life insurance to take out, it’s important to consider the three P’s: purpose, payout and price.

Purpose

It’s important to figure out if there is a purpose a life insurance policy might serve for you. 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.

Payout

In many cases, it may be necessary to purchase a larger policy if you have younger children or your beneficiaries have large financial needs. One industry standard suggests you should apply for a policy that is equal to 10 – 12 times your gross annual salary if you have young children.

For example, if you make $50,000 a year, consider applying for a longer term life policy with a face amount from $500,000 to $600,000. You can decrease this if your children are older and not as reliant on your income. You can also increase it if you want your spouse to be able to pay off big debts if you should die unexpectedly.

Price

Term life insurance is typically cheaper and might be a better fit for consumers who are mainly worried about monthly bills for their beneficiaries. Those consumers who want life insurance coverage for their entire lives might be better off purchasing a whole life policy, even though it’s more expensive.

That being said, your budget should play a part in what you can afford to purchase — factor in your current income and how much you’re willing to spend.

How To Determine How Much Life Insurance You Need

There are several ways to calculate and determine how much life insurance you need, such as how much you’ll need to replace your salary if you die, and how long you want to provide financial benefits to your beneficiaries.

Multiply Your Salary

In most cases, a reasonable amount for life insurance can be six to ten times the amount of your annual salary. For example, if you make $50,000 per year, it’s reasonable to purchase a policy for $300, 000 to $500,000. Some experts also recommend adding an additional amount — such as $100,000 — per child or dependent you have. Using the above example, if you have two young children, you may want to consider increasing your policy to $500,000 to $700,000.

Multiply Your Salary By The Number of Years Until Retirement

Using this method of calculating how much life insurance you need entails multiplying your salary by the number of years you have left until you reach retirement age or are ready to retire. This number should be a good estimate of the amount life insurance you need.

For example, if you earned $50,000 per year and have about 20 years until you expect to retire, you should probably purchase a $1,000,000 life insurance policy.

Use The Standard Of Living Method

The standard of living method refers to the amount of money your loved ones or beneficiaries would need —such as daily living expenses— to live on if you passed away. You’ll need to take this amount and multiply it by 20, or however many months you think your beneficiaries need to be able to replace your income.

For example, you and your family spend around $4,000 per month on necessities. You can consider purchasing a policy for $80,000, or more if you want to make sure your spouse has plenty of time to look for employment or another source of income to replace yours.

Use The DIME Method

DIME stands for debt, income, mortgage and education and this life insurance estimation method is used to help loved ones or dependents cover the various expenses left behind after you pass away.

This method should cover all outstanding debts of the insured person — such as credit card debt, mortgages, and student loans — and pay for any education for your kids and replace your income until your children turn 18.

For example, let’s say you have $200,000 left on your mortgage and $6,000 on your auto loan. You have one child who is 15 and you want to pay for their first year of college (around $20,000). Your income is $50,000 per year and based on your child’s age you’ll want to cover at least 3 years of your annual salary.

$200,000 + $6,000 + $20,000 + ($50,000 x 3) = $376,000

Using the above figures, you’re looking at purchasing a life insurance policy of $376,000.

While you’re calculating how much life insurance you need, you should also be aware of how much your life insurance premium will be and if you can afford it. In general, term life insurance policies are easier to understand and cost less, so it might make sense to go that route if you’re on a tight budget.

What Type Of Life Insurance Policy Is Best?

The best type of policy will depend on your personal and financial needs — you’ll typically choose between term and whole 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 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.

Consider whether you really need whole life insurance before making such a huge financial commitment. For instance, you might not need life insurance for your entire life. Once your children are grown, they likely 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.

Insurance Riders

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.

Remember to revisit your life insurance policy, especially as you experience life changes and as you age. The life insurance plan you have now may not fit your needs in a few years.

The Bottom Line: How Much Life Insurance You Need Depends On Many Personal Factors

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.

Another way to help you and your family prepare for your financial future starting today is to sign up for the Rocket Money^SM app to effortlessly track your spending, automate a budget and track your net worth.