Determining How Much Life Insurance You Need
For many, purchasing life insurance is a difficult task. First, they must gain an understanding of the different types, for instance, term versus whole life, and decide which is best for them. Then comes determining just how much insurance should be purchased. To simplify this decision, we have developed a short checklist of the criteria to consider.
Term vs. whole – Consider your stage in life and your financial situation. Term life gives you the ability to obtain a certain amount of financial coverage for a specific period of time (i.e., 10 years, 20 years). Whole life insurance provides long-term, permanent coverage (assuming premiums are paid) and builds a cash value which can be important for supplementing retirement funds and/or for other financial needs (e.g., a loan). Term life provides a death benefit to beneficiaries when the insured dies, whereas with whole life insurance, the premium is used to pay a death benefit when the insured dies, as well as to go toward savings which can be accessed while the insured is still alive.
Purchasing the same face value for an insurance policy (e.g., $100,000) provides a death benefit of that amount with both term and whole life insurance. However, because the whole life policy also builds a cash value while one is still alive, it is more costly than term life insurance.
Your reasons for buying life insurance – These range from covering burial/final expenses and replacing lost wages, to supplementing retirement income, helping to pay off the mortgage and other home expenses, transfer of wealth to heirs, paying estate taxes, gaining a tax-advantaged investment, paying for college, charitable gift giving, and business purposes. If your primary concern is covering final expenses, then term life is a good, affordable choice. If you care about many of the other reasons, then whole life is probably a better option.
Calculating how much insurance you need – In addition to considering the above reasons, there a few ways to calculate how much insurance to buy. One calculation focuses on one’s current financial situation in terms of common expenses, including debt, income, mortgage and education expenses. Consider the amount of debt in your name (i.e., credit cards, student loans, etc.) which others would incur if you died. Take your income and multiple it by how many years you want to provide income replacement for your loved ones should you die. One rule of thumb is considering how many years it will take for your youngest child (if a parent) to turn 18 or 21. Then look at your mortgage balance and add that to your insurance need. Finally, consider the cost of a college education for each of your children. Totaling all of these amounts is a good place to start in calculating your insurance coverage needs. It does not, however, consider that you may also have investments, savings accounts and other assets that could be used to help provide for your family in the event of your death.
Another simpler way to calculate insurance needs is to simply multiply your current income by a factor of, for example, 10, 20 or 30 years and use that figure as a ballpark number of the amount of coverage which should be purchased. Again, the simple calculation does not factor in other assets you may have and the fact that your income may increase substantially over future decades.
Determining how much life insurance you need is one of the most important financial decisions you will make. To make the best decision, reach out to an experienced life insurance professional who can share valuable insights and guidance.