Life Insurance

How Much Do I Need For Life Insurance

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 8 minute read

Think about the financial impact your death would have on your loved ones right now. Everything you normally spend your money on, from food and rent to hobbies and sports gear, would vanish along with your income.

If your debtors don’t get to your money first, they can use any savings you have. Still, that can’t last forever. They would also have to pay thousands of dollars for your burial. Now you must decide if you have sufficient life insurance to prevent this from occurring.

How much life insurance should I purchase?

Your requirements for life insurance will change as you go through life. Costs rise as people enter their prime earning years, have children, and amass debt. When you’ve finished paying off your mortgage, sending your children off to college, and are comfortably approaching retirement, your expenses will naturally begin to drop.

When your wealth is sufficient to provide for your loved ones in the event of your death and you have no significant debts or foreseeable future financial responsibilities, you may no longer require life insurance.

However, getting life insurance at a younger age would save you money and time. In a perfect world, you’d get all the insurance you’ll ever need in your twenties or thirties, long before you ever need it. It’s up to you to figure out how much life insurance you’ll need in the future, even if you can’t be sure of anything.

The amount of life insurance you actually need can change over time. The cost of life insurance, as well as the premiums required to maintain it, can be reduced gradually if you implement a strategy known as life insurance laddering. 

Instead of purchasing new, more expensive policies in the future, you can instead get lower life insurance now and sell off policies as your needs change. Your requirements might be determined in a few different ways. Pick the life insurance premium calculation technique that fits your needs best.

Best Debt-Protection Method for Shielding Survivors from Debt

This approach makes sure that your debts from life don’t come due when you’re gone.

You should get enough life insurance to accomplish the following:

  • Clear Any Debt Held Jointly. Whether it be a mortgage, home equity loan, credit card, or vehicle loan, chances are high that you and your husband or domestic partner are co-signers on at least one of these loans. To ensure that your loved ones are not left with financial hardship after your passing, you should have adequate life insurance coverage.
  • Pay for Huge Costs That Are Still to Come. Predictable, large expenses that you haven’t incurred yet should also be covered by your life insurance policy. The costs of sending your children to college are a prime example; the surviving spouse will need to come up with tens or hundreds of thousands of dollars per child.

To do this, one simply deducts present and future expenses from one’s assets. Information collecting is the most challenging phase. 

Let’s say your circumstance looks like this as an illustration:

  • Say you owe $375,000 altogether, including a mortgage amount of $300,000, $25,000 in credit card debt, and $50,000 in co-signed school loans.
  • You have two children and estimate spending $200,000 on their higher education over the next few years, bringing your total projected outlays to $400,000.
  • You have $50,000 in savings and $25,000 in a taxable brokerage account, so you don’t need to sell any of your assets right away. Put away any assets that you can’t quickly sell, including your home. This indicates that you have $75,000 available for use right now.

Formula: 

(Debts + Future Expenses) – Assets = Current Life Insurance Needs

The Multiply by 10 Method is Ideal for People Who Are Uncertain of the Future

If you know you need a sizable amount of life insurance coverage but you don’t have a firm grasp on your future needs, the “multiply by 10” strategy is an excellent place to start. In the eyes of many potential policyholders, this approach is adequate.

However, if you have or anticipate having considerable obligations and expenses, this approach may not be sufficient. Or it could be excessive if your income is sufficient to cover your costs and your net worth is large in relation to your age.

In terms of the calculation, it’s really simple. Take your annual gross revenue right now and multiply it by 10. Take, as an illustration, a pretax annual income of $200,000 as an example.

Formula: 

Gross Annual Income x 10 = Current Life Insurance Needs

The child Buffer Method Is Recommended for Parents of Young Children.

It’s common knowledge that raising a family may break the bank. Food, clothing, child care, and schooling are all obvious and costly necessities, but it’s the unexpected costs that may really add up when you have kids.

If something were to happen to you, the child buffer approach might help cover the cost of bringing up your kids until they become independent adults. It’s designed to help your partner or the children’s guardian get over the financial hump of putting your kids through college by replacing your income for ten years.

The average cost to raise a child born in 2015 until they reach adulthood is approximately $233,000, according to the United States Department of Agriculture. The majority of these expenditures, such as daycare, begin at an early age. However, young adults also face substantial costs in the future, such as college tuition.

If you and your partner already have children and split childcare costs evenly but aren’t otherwise in over your heads financially, the child buffer approach may work for you. While the national average cost of raising a child is almost $16,000 per year, that’s only half of what each parent contributes to a two-parent family.

It’s a touch more involved than just multiplying by 10, but not by much. Let’s imagine you have three kids and a pre-tax income of $200,000.

Formula: 

(Gross Annual Income x 10) + 100,000 x Number of Kids = Current Life Insurance Needs

The income Replacement Method Is Best for Senior Candidates

Using this strategy, you can try to make up for a large portion of the income you’ll lose over the course of your working life. In terms of financial obligations and costs, it is silent. 

Moreover, the accuracy decreases with age due to the multiplicative effect of wage increases or, more dramatically, professional changes on your lifetime earnings.

Therefore, if you are an older candidate for life insurance and you know how much you can expect to earn in the future, this is the method for you. There is some wiggle room around the age of 50, but at that point, you may safely label yourself as old.

Let’s imagine you’re 50 years old and making a yearly salary of $250,000. Since your target retirement age is 65, you still have 15 years to go. That adds up to:

Formula: 

Gross Annual Income x Number of Years Until Retirement = Current Life Insurance Needs

Standard of Living Method and Best for Reducing Financial Sacrifice to Survivors

Using this strategy, your loved ones will be protected from financial hardship in the wake of your passing. With appropriate life insurance, your partner and any dependents can continue living well even if something were to happen to you.

Your present spending rate as a family and the number of years you need to provide for will determine the exact amount of coverage needed to sustain your survivors’ level of life. This strategy typically only generates funds until the surviving spouse enters retirement, at which point additional retirement income sources such as Social Security become available.

To determine how much money you need to maintain your current quality of life due to insurance, you should first determine your annual household expenditures. 

It’s easy to estimate your annual expenditure by multiplying your current monthly total by 12, but for a more accurate picture, it’s better to add up your expenses one month at a time over the course of a full year.

The number of years of support you need to pay for is equal to your annual spending amount multiplied by the number of years. A good starting point is the number of years before your spouse retires if you don’t have a firm deadline in mind.

So, your partner wants to retire in 20 years and you spend $60,000 each year ($5,000 per month on average). This is how your math works out:

Formula: 

Annual Spending x Years to Cover = Current Life Insurance Needs

The DIME Method is the Best for the Accurate Replacement of Major Expenses & Income.

As an acronym, DIME refers to debt, income, mortgage, and education. To get a clear picture of how much life insurance your family needs, the DIME technique takes into account all of these costs. 

Get started by totaling up each of these costs:

  • Joint debts include all current credit card balances, home equity loans and lines of credit, student loans, personal loans, and car loans.
  • Earnings. What you bring in on a yearly basis after taking into account all applicable taxes and other deductions
  • In the case of a mortgage, the total amount still owed on the loan is separate from the home’s fair market value.
  • For the purpose of this definition, education will include all costs associated with your children’s education, from preschool to high school and beyond.

Consider also the length of time you wish to guarantee financial stability. Typically, it’s the amount of time your loved ones will need to get by on the money.

Follow these steps to determine your future family budget using the DIME method:

  1. Total up what we know about loans, tuition, and the mortgage.
  2. Compile the sums from the various groups.
  3. To calculate how much you will need to save, multiply your annual gross income by the number of years you would need to make provisions.

Let’s assume, for the purpose of argument, that your total monetary obligations consist of $300,000 in mortgages, $100,000 in other debts, and $250,000 in anticipated education costs. You have an annual income of $80,000 and you need to guarantee your family’s well-being for the next 20 years. 

Here is how you might apply the DIME approach to a calculation:

Formula: 

(Debt + Mortgage + Education) + (Gross Annual Income x Number of Years) = Current Life Insurance Needs 

Bottom Line

Existing conditions evolve. Things in life just do. Future events are beyond our ability to foresee. You already know everything mentioned here. So, you’re aware that, no matter what happens, you’ll need to figure out how much life insurance to buy.

The good news is that you can get there using any of the aforementioned approaches to calculating life insurance premiums. To do this, you need only make conservative forecasts regarding your future income and wealth growth, as well as educated guesses regarding the direction your life will follow. 

Then, select the term life insurance provider that best meets your needs. However, what if your predictions don’t come true and you end up requiring more life insurance than you initially anticipated? You can always get more, but it’s advisable to do it as quickly as possible.

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