How Much Life Insurance Do I Need?
By Georgia Rose, nerdwallet.com
You need enough life insurance to cover your obligations after you’re gone. Start by looking at your existing financial needs and resources.
It’s hard to pinpoint how much life insurance you should buy down to the penny, but you can make a good estimate by using our life insurance calculator below.
In general, you should add up your long-term financial obligations, such as mortgage payments or college fees, and then subtract your assets. The remainder is the gap that life insurance will have to fill.
How to manually calculate how much life insurance you need
Follow this general philosophy to find your own target coverage amount: financial obligations minus liquid assets.
Step 1: Add up the following items to calculate your financial obligations:
Your annual salary multiplied by the number of years you want to replace that income.
Your mortgage balance.
Any other debts.
Any future needs such as college fees and funeral costs.
The cost to replace services that a stay-at-home parent provides, such as child care, if applicable.
Step 2: From that total, subtract liquid assets, such as savings, existing college funds and current life insurance policies.
The number you’re left with is the amount of life insurance you need.
You can also calculate your needs on a Life Insurance Calculator.
3 ways to estimate how much life insurance you need
If you want to quickly determine your existing life insurance needs, an estimate can be an easy way to get a value. These methods are better than a random guess but often fail to account for important parts of your financial life.
Use the calculator above to get a more refined idea of how much life insurance you need, then compare that value to these estimates.
1. Multiply your income by 10
The “10 times income” guideline is often shared online, but it doesn’t take a detailed look at your family’s needs, nor does it take into account your savings or existing life insurance policies. And it doesn’t provide a coverage amount for stay-at-home parents, who should have coverage even if they don’t make an income.
The value of a stay-at-home parent’s work needs to be replaced if he or she dies. At a bare minimum, the remaining parent would have to pay someone to provide the services, such as child care, that the stay-at-home parent provided for free.
2. Buy 10 times your income, plus $100,000 per child for college expenses
This formula adds another layer to the "10 times income" rule by including additional coverage for your child’s education. College and other education expenses are an important component of your life insurance calculation if you have kids. However, this method still doesn’t take a deep look at all of your family’s needs, assets or any life insurance coverage already in place.
3. Use the DIME formula
This formula encourages you to take a more detailed look at your finances than the other two. DIME stands for debt, income, mortgage and education, four areas that you should account for when calculating your life insurance needs.
Debt and final expenses: Add up your debts, other than your mortgage, plus an estimate of your funeral expenses.
Income: Decide for how many years your family would need support, and multiply your annual income by that number.
Mortgage: Calculate the amount you need to pay off your mortgage.
Education: Estimate the cost of sending your kids to school and college.
By adding all of these obligations together, you get a much more well-rounded view of your needs. However, while this formula is more comprehensive, it doesn’t account for the life insurance coverage and savings you already have. It also doesn’t consider the unpaid contributions a stay-at-home parent makes.
Tips for calculating how much life insurance you need
Keep these tips in mind as you calculate your coverage needs:
Think of life insurance as part of your overall financial plan. That plan should take into account future expenses, such as college costs, and the future growth of your income or assets.
Don’t skimp. Your income likely will rise over the years, and so will your expenses. While you can’t anticipate exactly how much either of these will increase, a cushion helps make sure your spouse and kids can maintain their lifestyle.
Talk the numbers through with your family. How much money does your spouse think the family would need to carry on without you? Do your estimates make sense to them? For example, would your family need to replace your full income or just a portion?
Consider buying multiple, smaller life insurance policies, instead of one larger policy, to vary your coverage as your needs ebb and flow. For instance, you could buy a 30-year term life insurance policy to cover your spouse until your retirement and a 20-year term policy to cover your children until they graduate from college. Compare life insurance quotes to estimate your costs.
