How Much Life Insurance Do You Need?
Simple math can determine the right amount of coverage to protect your family.Lucky Business / Shutterstock
Having life insurance is the best way to make sure your family will be taken care of if something happens to you and you're no longer around. But how much life insurance is enough?
Finding the golden number isn't as complicated as you might think. It comes down to covering your income and your family’s future financial needs.
In general, you should have enough insurance to replace the money you're bringing into the household and pay for financial obligations, such as your mortgage, your kids' college costs and final funeral expenses.
But how do you pinpoint an accurate coverage amount to protect your family?
3 ways to calculate your life insurance needs
Determining the amount of life insurance you should buy typically requires a calculation involving: income replacement; expected financial obligations; and any liquid assets you have, such as savings, which could help take care of your loved ones.
Here are three proven methods to figure out how much coverage you need. Choose whichever is likely to work best for you.
Option 1: Multiply your yearly income by 10 or 12
This method focuses primarily on income replacement. Simply multiply your annual salary by 10 or 12 years to get a rough coverage amount that will provide your family with 10 or more years' worth of your current income.
This option is a good way to offer a family some support, but it may not cover all of your dependents' future needs. It also doesn’t take into account any savings you might have or any existing life insurance you might have.
You'd have to subtract all of that as a final step.
It's not a good method for calculating the insurance required for a stay-at-home parent, who needs coverage as much as a working spouse. If you're a stay-at-home mom or dad, at the very least you should have enough insurance to cover child care costs if you're not there to take care of the kids.
Option 2: Multiply your income by 10 to 12 and add college expenses
This method goes a step beyond income replacement and accounts for some of your children's future needs, especially college expenses.
How much extra coverage should you buy for your kids' college? Well, keep in mind that in 2018, the average cost of a four-year degree — including tuition, fees, and room and board — was $85,480 at public colleges and $194,040 at private ones, according to the College Board. And those prices are only going up.
If your children wind up qualifying for financial aid, choosing a shorter program or not going to college, then your additional coverage for their higher education would provide them with a financial cushion for other expenses.
This formula also doesn’t consider any savings or other assets you might have. Again, you'd want to subtract the value of your assets from whatever coverage amount you come up with.
Option 3: The DIME formula
This formula accounts for most people's major expenses and future needs for a family. Grab a pen or open your calculator app and start adding.
(D)ebt and final expenses. These include funeral costs and things like outstanding credit card debt. (Not your mortgage.) Note that the cost of the average funeral and burial is at least $9,000, according to the funeral pricing website Parting.com.
(I)ncome. Estimate the number of years your family will need the money you provide and multiply your current yearly income by that number. For reference, your family will likely require support until your youngest child graduates high school.
(M)ortgage. Add how much money your family would need to pay off the balance of your mortgage.
(E)ducation. Consider how much it would cost to send your kids to college. College costs can vary widely by region. To get an accurate number for your state, check the tuition and fees of private or public colleges near you.
The DIME method gives a much clearer picture of how much life insurance you should get — but once again, there's no accounting for your savings and investments. This option also isn't good for factoring in the value of the work performed by a stay-at-home parent.
Key factors to consider
To find the clearest possible amount of life insurance that will cover your family’s needs, start with the DIME method. Then, think about a few additional considerations:
Child care. A stay-at-home parent provides child care for $0, and replacing that care can be costly if one parent dies. Do some research on what local child care providers charge, to get an idea of the costs. Also, consider any expenses for your children’s specific needs — such as if they have ongoing or chronic conditions.
Include debts, liabilities, current and future expenses — especially any debts your dependents have co-signed with you. They will be liable to cover those debts if you're suddenly out of the picture. Also, make sure there will be enough for your dependents to pay off loans tied to collateral, such as your car loan for that vehicle out in the driveway.
Your health and age. The younger and healthier you are, the more affordable your life insurance will be, especially for a large coverage amount. If you’re older, you would normally need less coverage because your children would be older and would be independent sooner. Consider that your spouse might receive survivor benefits, or 100% of your Social Security benefit if you die.
Affordability. Think of what you can afford to pay for insurance premiums each month. The more coverage you choose, the higher your premiums will be. Decide between term life insurance or whole life or another form of permanent coverage. Term life insurance lasts for a set number of years and expires, while whole life covers your entire life. Since whole life policies can cost six to 10 times more than term, most people opt for term.
Life is expensive — but the peace of mind that life insurance can provide is priceless.
Determining your coverage amount is the first step toward buying a life insurance policy, and all it takes is some common-sense arithmetic. It's really not too difficult.
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