How much life insurance do I need?
Published 12:31 PM EDT, Wed February 28, 2024
ljubaphoto/iStockPhoto
Life insurance is designed to cover various financial obligations after you pass away, so calculating an appropriate coverage amount is crucial. While your financial situation and goals ultimately determine your coverage needs, you can use multiple methods to get a rough estimate. Some methods focus on income replacement while others account for debts and expenses. You can use them as a guideline as you review your family’s needs and seek professional advice.
We receive compensation from our partners for Featured Offer placements, which impacts how and where their offer is displayed.
Evaluating your financial obligations
To start, identify all the financial obligations you’d like to cover for your loved ones. This may include:
- Your income through retirement age or beyond
- Estate taxes
- Your mortgage and other debts
- Funeral and estate settlement costs
- Child-care costs
- An emergency fund
- Your children’s college fund
You can use the Debt, Income, Mortgage and Education (DIME) method for a simplified calculation. Add your debts, desired income replacement amount, mortgage balance and children’s future education costs. Your life insurance coverage amount should be equal to the sum of those obligations.
After totaling your estimated financial obligations, you may also choose to subtract the value of your assets — money in various savings accounts or property your family would sell when you pass away, for example.
If you have existing life insurance coverage, such as a policy through your work, this can also decrease the coverage amount needed. However, your coverage through your employer may end if your employment ends.
Estimating your family’s monthly expenses
Another way to calculate how much life insurance you need is to look at your family’s expected monthly expenses once you pass. You can start with your current budget to identify common living expenses and amounts. Some example monthly expenses may include:
- Housing payments
- Utilities
- Insurance policies such as auto and home
- Food
- Transportation costs
- Health care and medicine
- Clothing
- Pet care
- School-related costs
- Personal care items
- Debt payments
- Child-care costs
As you calculate these expenses, consider any costs that may arise for your family after you pass. For example, you might not pay for child care now, but your spouse may need the help without you around.
Inflation will also increase many monthly expenses over time. A good rule of thumb is to include a 3% inflation rate in your calculations.
Calculating your outstanding debts
At the very least, your life insurance policy’s death benefit should cover all the monthly debt payments that continue after your death. This includes debts such as mortgages, home equity loans, car loans, personal loans, credit cards, student loans and business loans.
For secured debts such as a mortgage, creditors can otherwise seize the assets if your family can’t make the payments. In that situation, your family may need to sell your home and other assets to cover the debt.
In most cases, your loved ones aren’t responsible for your outstanding debt unless they’re a cosigner or joint account holder.
Note that student loans are a special case since the government and some private lenders such as SoFi will discharge the loans upon death. Check your loan contracts for discharge clauses — if they have them, you may be able to exclude the debt when you determine your life insurance needs. However, if you were married when you took on student loans while living in the following states, your spouse would be responsible for the debt: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Factoring in future education expenses
If you have children, you may want to consider their future college expenses to ease their financial burden and reliance on student loans if you pass. This includes costs such as tuition, fees, transportation, materials and room and board.
When estimating education expenses, you’ll want to consider factors such as:
- How many kids you have
- Whether they’ll attend public or private institutions
- If they’ll live at home, on campus or off campus
- How many years they’ll attend
- How inflation will increase tuition costs
Since the calculation is complex and involves some uncertainties, you might consult a college cost projector for a total cost estimate. This tool will feature average tuition and fee costs for several types of institutions and estimated costs for room and board. Note that you’ll want to account for existing college savings money and estimated financial aid funds such as grants.
As a quick alternative to calculating education costs, you can follow this rule of thumb: add $100,000 to $150,000 per child to your life insurance coverage amount.
Assessing your income replacement needs
You’ll typically determine your survivors’ income replacement needs based on your estimated remaining working years. You’ll also want to consider any remaining income sources your loved ones would have, such as your spouse’s wages and any Social Security survivor benefits.
One popular income replacement calculation method involves simply multiplying your yearly income by 10. So, if you earn $75,000, you’ll want $750,000 in life insurance coverage. While this might suffice if you pass away near retirement, you may prefer an age-based calculation method to account for more years of lost wages.
For example, you might buy 30 times your income in life insurance coverage if you’re under 40. The amount needed would then reduce to:
- 20 times your income in your 40s
- 15 times your income in your 50s
- 10 times your income in your early 60s
Income replacement may become less important after your 60s, so you might buy coverage based on your net worth instead.
Considering funeral and estate settlement costs
Final expenses can be financially significant, so you’ll want to ensure your death benefit will cover them. A funeral and burial have a median cost of around $7,848 compared to around $6,971 for a funeral and cremation, according to 2021 data from the National Funeral Directors Association. These figures don’t include expenses such as a burial marker or monument and cemetery fees. You may also prefer upgrades or add-ons that could increase your funeral expenses.
The estate settlement process can get costly as well. Your loved ones may need to hire legal professionals, pay for asset appraisals or transfers, settle outstanding debts and medical bills and cover various estate administration fees. Depending on your location, both state and federal estate taxes could also apply.
Evaluating your additional financial goals
Life insurance coverage can help with more than replacing income and covering important costs — you may have long-term financial goals you want to support even after you pass. Maybe you want to provide a large inheritance for your loved ones or give them money to invest. You might also want to leave behind funds to start or continue a business or name a charity as your beneficiary.
If your policy has a cash value component, your life insurance policy could help you meet financial goals during your lifetime. For example, to free up money in retirement, you might borrow against your cash value, make regular withdrawals from it or use it to pay your premiums.
Just know that insurers usually set limits on how much of the cash value you can borrow, withdrawals may be subject to federal income tax and your policy may lapse if there are insufficient funds to pay your premiums.
Additionally, only permanent life insurance policies offer a cash value component; term life insurance policies do not.
Consulting with a financial advisor
You can work with a financial advisor to best understand your life insurance and estate needs. They’ll examine your whole financial picture — including your income, assets, debts, expenses and goals — to help determine the right life insurance policy. If your advisor is licensed to sell insurance, you may be able to buy a policy through them.
Before choosing an advisor, thoroughly research their background, experience and credentials. Check for proper state licenses, adherence to ethics codes and any past disciplinary actions. You can see advisors’ records through the Financial Industry Regulatory Authority’s (FINRA) BrokerCheck. Additionally, review the advisor’s pricing.
Frequently asked questions (FAQs)
Generally speaking, yes. But how you answer the question depends on factors such as how many people are relying on you for income and the size of your financial assets. If you don’t have any dependents, then life insurance may not make sense. However, if you’re younger and have a spouse, parnter or children that rely on your income, term life insurance is a great way to protect their financial security if you pass. In many cases, you can purchase hundreds of thousands of dollars of coverage for less than $100 a month.?
That being said, if you have considerable wealth stored in savings, investment, and retirement accounts that are enough to provide financial stability to your dependents, it may not make sense to buy a life insurance policy.
It depends. If you’re in your 20’s or 30’s, it may make sense to buy a term life insurance policy. These policies offer a lot of coverage for relatively low premiums. Because of that, term policies can provide financial stability for young families that have mortgages and debt. However, term policies provide a death benefit for a set period of time (up to 30 or 40 years). If you don’t pass by the time the policy expires, you lose the death benefit unless you can renew the policy.
If you’re interested in buying a policy that builds value over time, whole life and universal life policies (known as “permanent” policies) offer a death benefit and a cash value account that acts like a savings or investment account depending on the type of policy you choose. Additionally, permanent policies are designed to cover you for life instead of a set period of time. Not only does the policy offer a death benefit, but you can use the cash value to withdraw money, borrow against and pay your premiums.
In general, you want to consider the following factors when you’re considering life insurance: your age, income, assets, dependents and budgets. Term policies are affordable and widely considered a good way to protect your dependents for up to 30 or 40 years. Permanent policies tend to cost significantly more than term policies but last your whole life and offer a cash value component you can borrow and withdraw from and use to pay your premiums.
Editorial Disclaimer: Opinions expressed here are the author's alone, not those of any bank, credit card issuer, airlines, hotel chain, or other commercial entity and have not been reviewed, approved or otherwise endorsed by any of such entities.
This content is for educational purposes only and is not intended and should not be understood to constitute financial, investment, insurance or legal advice. All individuals are encouraged to seek advice from a qualified financial professional before making any financial, insurance or investment decisions.
Note: While the offers mentioned above are accurate at the time of publication, they're subject to change at any time and may have changed or may no longer be available.
Want to connect with CNN Underscored Money on partnerships, inquiries or have feedback? Contact Us
