A life insurance policy purchase is a smart move that not only ensures financial coverage for your own future but also covers your loved ones in case of a mishap. If you find yourself asking, “How much life insurance do I need?” then you are at the right place. We already covered the best life insurance companies so we can help you find the best provider, we will help you discover how much insurance you really need.
The type of life insurance you require depends on a number of personal and financial factors. To begin with, you need to consider your income and calculate the maximum monthly premium you can afford to pay for your insurance. Additionally, life insurance coverage may depend on the financial goals you have in mind. There are some formulas that can help you in the process, but it all comes down to the understanding of your specific needs.
Life Insurance Explained
Life insurance is a contract signed between you and your insurance provider. During your lifetime, you regularly pay premiums to the insurance company. When you pass away, the insurer will provide your beneficiaries with a lump-sum payment.
Your beneficiaries may use the amount for whatever purpose they require. Often, this includes paying the mortgage, going to college, and taking care of everyday bills. The safety net of life insurance ensures that your family does not go through a severe financial jolt at the time of your death.
There are two primary types of life insurance explained in our review:
Term Life Insurance Explained
Almost 71% of all customers opt for term life insurance. It is the most popular and affordable life insurance option available in the market today.
Term life insurance sets a specific period for insurance premiums to be paid, at the end of which you will get a lump-sum amount. If you pass away during the course of the insurance, your family will get a full amount of the death benefit.
Permanent Life Insurance Explained
Permanent life insurance is more pricey than term life because it builds a cash value and lasts for a whole lifetime. You can end the policy whenever you wish. However, you’ll be able to get some returns back only in case you’ve had your insurance for a long time and managed to build up enough cash value. You can also change your policy and keep some death benefits in exchange for paying reduced premiums. Every case is different, so discuss the option of lower premiums or no premiums at all with your insurance company.
Permanent life insurance offers four types of insurance:
- Universal life insurance
- Whole life insurance
- Variable life insurance
- Variable universal life insurance
Who Needs Life Insurance?
The recommended life insurance coverage is based on the requirements of the individual looking for insurance. Different people require different life insurance policies to fulfill their needs.
If you’re wondering where to begin, you can start by answering the question, “How much life insurance do I need?”
Discussed below are some categories of people who are more likely to benefit from life insurance.
Parents with Young Children
Unless the family has enough savings to take care of themselves in case of a mishap, parents with young children should look for a life insurance policy. A term life insurance would perfectly suit this family.
Spouses Providing Most of the Income
Ideally, you would both want to be able to work and earn equally in a marriage. However, that’s not the case when one parent stays home looking after the kids. If you’re the spouse providing most of the family income, perhaps you should consider the option of a life insurance policy. Such a policy will safeguard your interests and come in handy if something happens to you. If you’d like to know, “How much life insurance do I need for my spouse?” — keep on reading our article.
Older Adults without Savings
Older adults at the age of retirement without any savings can ideally opt for whole life insurance or universal life insurance. You should carefully look into each policy coverage before choosing the right plan for you.
What Is the Minimum Amount of Life Insurance You Need?
To calculate the minimum amount of life insurance you need, take into consideration the minimum life insurance payout you can easily manage.
How Do I Calculate How Much Life Insurance I Need?
With the help of an online life insurance calculator, you can figure out the necessary coverage amount according to your requirements.
You can also follow these tips to find out how much insurance you need:
- Tally up the resources you currently have. Find out the amount of income you have after subtracting taxable income and liquid assets.
- Calculate your financial obligations by adding your debt to your expenses.
- The coverage gap between your obligations and liquid assets is usually the amount of insurance you should get.
This concept is further explained below.
Resources
To determine the insurance coverage you need, you should be fully aware of your resources. Most insurance companies suggest that your life insurance payout should equal 6-10 times the amount of your annual salary.
A person earning $70,000 per year should look for a life insurance policy that provides coverage ranging from $420,000 to $700,000. The coverage can either come in the form of permanent life insurance or term life insurance.
Expenses
All expenses that you currently undertake, including the debts you have and the cost of raising children, should also be taken into consideration before deciding on the coverage amount. The expenses vary from family to family, based on their standard of living. Naturally, families with children who will attend college have higher demands.
Financial Obligations
You can calculate your financial obligations by adding debt to your expenses. The financial responsibilities for a typical family may include mortgage payments and student loans, among others. Do remember to list down all of your obligations.
Once you have factored in all of these aspects, you should do the math and determine the required amount for your insurance coverage. The insurance coverage should cover your family’s costs until your children can provide for themselves.
How Much Life Insurance Do I Need? Life Insurance Rules of Thumb
There are three life insurance rules of thumb to help you find the best life insurance.
Income Approach
The first method is to multiply your income by 10 and find the best possible life insurance coverage in that range. Before you get to the multiplication part, make sure you compute your annual income in full, subtracting all the related tax fees. The annual income you make could be a good way to calculate your life insurance coverage. The sum you get would cover your family’s needs for 10 years.
Income Plus Education
The second approach to getting the insurance coverage you need is to multiply your income by 10 and add $100,000 per child for college expenses. College tuition nowadays is expensive. That’s when this policy comes in handy for your family.
If you have three children, you should ideally look to get coverage of $300,000 plus your annual income multiplied by 10. This rule of thumb is helpful for most people with children.
The DIME Formula
Another principle used to compute the life insurance coverage you need is the DIME formula. The acronym DIME stands for Debt, Income, Mortgage, and Education. The DIME methodology is quite comprehensive and includes all aspects of your income tax approach.
The following information should be considered for the DIME approach to calculate how much life insurance you actually require:
- Debt: Add up your debts
- Income: Figure your annual income and multiply it by the number of years your family will need support for
- Mortgage: Calculate the amount left to be paid off on your mortgage
- Education: Estimate the cost of your children’s education
However, the DIME approach does not consider the resources you currently own or your family’s personal needs. It may leave your family with either too little or too much insurance.
Should You Use Life Insurance as an Investment?
Most people use life insurance as an investment option to build cash value and report gains in investment over a period of time. To be clear, most of the life insurance policies purchased today act as a form of security and risk management. The death benefit is an added hedge that provides your family with cash payment in the unlikely event of your premature death.
Life insurance investments are growing in popularity as many people now consider them term insurance policies. Life insurance is also used as an investment avenue because of its tax benefit. The death benefit generated through life insurance can save thousands and even millions in taxes. Rich families are known to use dynasty trusts and other life insurance policies to pass their money over through generations without paying Uncle Sam’s share.
Life insurance coverage can also be used as a means to plan your retirement. You can pay installments while you work and then benefit from monthly payouts for the rest of your retired life.
So, if you find yourself asking, “Is life insurance worth it?” then you should possibly go through the reasons above and assure yourself of its investment potential.
Alternatives to Life Insurance
If you haven’t yet decided on the right life insurance plan for yourself, we have three other alternatives for you.
Invest and Save
The first possible course of action you can follow is to start investing and saving. It is by far the simplest alternative to life insurance. To choose the right benefits or coverage options for you, first look into the differences between life insurance vs. savings account.
Mortgage Insurance
Mortgage insurance, unlike life insurance, is designed to protect a mortgage lender in case something happens to the policyholder or there’s a loan default. If you’re afraid your family wouldn't be able to afford mortgage payments on their own, mortgage insurance could be a nice alternative to help them pay the mortgage balance.
Accidental Death and Dismemberment Insurance (AD&D)
Accidental Death and Dismemberment Insurance protects against unforeseen events that could lead to death, loss of sight or hearing, paralysis, etc. It’s low-cost insurance that can be an addition to your main life insurance policy or can come as a part of your employee benefits. You can also purchase AD&D on your own from insurance companies, credit unions, or your bank.
AD&D Insurance vs. Life Insurance
Life insurance offers financial protection in most cases of your death, while AD&D Insurance covers you only in the event of unexpected death not related to natural causes or illness.
Conclusion
We hope that you are now aware of different life insurance types and other coverage alternatives. You can now decide what insurance would better suit your needs or whether you require one at all. You won’t ask yourself again, “How much insurance do I need?” since different methods of calculating the coverage amount will help you with the matter.
