How Much Life Insurance do you Need?

How much life insurance should you get? How much life insurance do you really need? What’s a good rule of thumb for how much life insurance to buy? This seems like a simple question on the surface but boy does it have a lot of answers.

The final answer on how much life insurance you need will also depend on your budget, especially if you  if you have heart disease, heart conditions or another high risk issue to consider.  AFib, heart stents, high blood pressure will make your life insurance more costly if you pick the wrong company.

Life insurance is for the people left behind-your immediate family-and that part is pretty straightforward, however your policy may be used to meed a variety of long term financial planning goals like:

  • educational funds for your children
  • funds for a spouse’s retirement
  • paying off a mortgage
  • caring for dependent siblings or parents.
  • establishing a legacy with a charity of your choosing.

So when you ask yourself “how much life insurance is enough,” you have to put your future thinking hat on. What does life look for your family the day after you die? 100 days after you die? 10 years after you die?

Ask these questions of yourself because we ask them of our clients daily. Why not start a conversation with one of our underwriting experts for help? A guiding hand can shed some light on the subject and the advice is always free.

Hоw much life insurance do you need?

If you are confused, that’s normal. We will try to break this down into as simple of an answer as we can, even though it is multifaceted.  Read below for a few options to determine what you need, and finally our recommendation on the best method to determine what you need.

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What are you leaving behind? Savings vs. debt method.

If you are swimming in money like Scrooge McDuck, do you even need life insurance? Maybe not. If you are leaving behind a sizable estate (and have those estate taxes figured out), we might advise you against life insurance entirely.  Good for you!

How much life insurance do you even need life insurance? With a sizable estate, maybe not.

However, maybe you did not save as much as you wanted to. Maybe you’re not swimming in money. Or maybe you are a normal, hard working person who has some savings and some debt to consider.

A mortgage is the largest debt that most people will see in their lives, and with a mortgage it is best to have a life insurance policy large enough to cover the remaining balance.

This is a minimum number, and it assumes you are not re-financing the balance or moving into a bigger more expensive house in the future.

Having this covered as a minimum is extremely important.  If you die unexpectedly, your family can inherit the house free and clear and be free of the burdens of house payment.

What about your other debts? Tally up every debt, then subtract your savings, and you will reach the lowest number you could safely apply for in regards to life insurance.

Recap:
Add up all debts, then subtract any savings. This is the minimum amount of life insurance that you should consider.

What are you spending monthly? The actual expenses method.

How much are you spending with your family monthly on life’s essentials?  The most accurate way to determine your monthly needs is to use a personal budget software package like you need a budget (YNAB), but you can also use your bank statements to estimate spending.

You might think that $500,000 in term life insurance coverage is sufficient, because after all, it’s a lot of money.

Think about this carefully though, because grieving takes longer than you may think.  We often think of the grieving widows because there are more females who lose a spouse than males, however recent research says that men suffer more from being bereaved.

Your family’s grief could last for years after you die, and if your monthly expenses are high, that $500,000 could be gone before your family is ready to start working again.

How long your family will grieve depends on your relationship, but many families take five to seven years to fully process the shock. In our case, if your monthly expenses were $8,350 or more, that $500,000 would be burned before the grieving process was complete.  Then what?

Recap:
Purchase at least 10 years (or 84 months) worth of expenses in life insurance to let the family grieve.

So many calculators.  Which one to use?

Some people absolutely love calculators for finding life insurance information, and so do I.  Most calculators will lead to spammy websites who will sell your personal information, so tread carefully in this regard.  Look for something that doesn’t ask for personally identifying information:  This life insurance calculator is one of the best ones on the web for figuring out how much to purchase.

For best results when using the calc:

  • do not include social security benefits
  • over-estimate your future income needs (90% of current combined income)
  • use the free quote tool provided on this site to compare actual life insurance rates
  • talk with one of our underwriting experts.  After all, it’s free

The WRONG approach: Income multiplier method.

Life insurance trade groups and old training manuals often used an income multiplier as a “rule of thumb” for how much life insurance to apply for.  This method assumed that 7x your annual income would be plenty of life insurance if you did not have children, and 10x would suffice if you did.

Simple enough, right?  Except it is wrong!

First off, check out the calculator below.

To illustrate the point, let’s take a look at John who makes $75,000 per year.

He is 45, retiring at 65, and plans on a 2% increase annually.

Protecting his family, John had 10x his income in life insurance and was happy with his $750,000 policy.  However, John stands to earn over one $1.8 million from age 45-65.  If he died tragically at 45, when his life insurance paid out it would still leave his family short $1 MILLION dollars!  Yikes!

When the twin towers fell on 9-11, September 11th victims compensation fund placed the value of the victims’ future earnings at 16X their annual salary, with some multiples being even higher than that.

If 16X annual income was good enough for the government, why are insurance agents still under insuring their clients with half of that amount?

Worse still, most employer sponsored life insurance plans only ensure 1X – 5X your income, and that is certainly not enough.

Put plainly, an income multiplier is not the best way to find out how much life insurance you need for your family.  This rule of thumb is an outdated one and it is best to avoid it.

Recap:
The “Income Multiplier” method is outdated.  Don’t use it.  Sadly, most group life insurance policies through your employer still use this method and under insure their employees.  Extra coverage is crucial if you only have life insurance through work.

Preferred Choice: Income Forever Method

I’m conservative in financial planning by nature, so this is the method that I recommend.  I prefer a calculation that allows my family to create lifetime income from a lump life insurance payout and I feel you should to. The Income Forever Method uses a low interest rate (usually 4%) and conservative financial management to make a lump sum last a lifetime. Divide your annual salary by this interest rate and you will get a big number your family could live off indefinitely.

How much life insurance do you need? Life insurance lump sum income forever method

Take John again.  He’s still earning $75,000 annually and he would need $1.625 Million in life insurance coverage to generate his salary for life.

The obvious flaw in the lump sum method is getting the interest rate you project.  I don’t know about your savings account, but mine is not earning 4% currently.  How will that 4% happen?

Are your family members adept at investing? If not, who would they entrust that lump sum to? What about inflation?  What about market fluctuations?

Work with one of our underwriting experts and we can guarantee income for your family for life so that you don’t have to worry about it.

The Real World Solution:  Buy what you can afford

This is reality folks.  The ideal method is income forever, however life insurance can be expensive if you have heart problems like atrial fibrillation, CHF, or hypertension.  What to do?

Buy what you can afford, and buy it now.

    • Life insurance is a long term plan, and it absolutely must be affordable long term.  Do not get wrapped up into the excitement of a great sales pitch.  Buy what you can honestly afford, because you will be making that monthly payment for a long time.
    • The best life insurance policy for you is the one in force when you need it, so buy what you can afford!  What is the point of having lots of life insurance coverage if you do not pay and it lapses?  Why make a donation to a life insurance company if it doesn’t benefit your family?
    • You will never be as young as you are today, and you will never be as healthy as you are today.  Buy coverage now while it is less expensive.  Add onto that coverage at a later date if budget is an issue.

In the end, it all comes down to your personal budget.  Throughout this article we’ve explored some routes to answer “how much life insurance do I really need.”  Different methods will lead you to a different number, and your case is unique.

No matter how you get to the number, work with an expert and buy what your budget allows.

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