Life insurance can be one of the most important purchases you make. When buying a life insurance policy, you are securing future financial protection for the ones you love.
That is nothing to take lightly, but actually obtaining life insurance policy coverage can be a headache-inducing process. There are a whole variety of factors that go into your life insurance policy, and you want to make sure you get the appropriate life insurance coverage for your spouse and children.
Outlined below is what you should be calculating to figure out the best life insurance coverage for you. This guide aims to assist you on your life insurance shopping journey since the road to the perfect life insurance policy can sometimes be a winding one.
What is Life Insurance Policy?
The life insurance payout is expected to be enough to cover expenses and debts, such as a mortgage, you were responsible for when you were alive. In a way, it supplements the income lost upon your death. Whoever you name as a beneficiary, typically these are people you consider your dependents, such as your spouse and children, but do not always have to be, will receive the money.
There are a few different categories and subcategories when it comes to life insurance policies. The type of coverage you opt for greatly affects your life insurance premium rates.
While the types of life insurance are not the focus of this piece, it will be helpful in your life insurance shopping to get a brief understanding of the levels of coverage offered by life insurance companies.
What Types of Life Insurance Are There?
How much financial coverage you need or want under each life insurance category varies based on your calculated assets, a process that will be explored later in this piece.
Term life insurance refers to a policy that ends after a set number of years. You can usually have these life insurance policies active for anywhere from 10-30 years. Once the term life insurance policy expires, you will have to repurchase a life insurance policy should you wish to still have life insurance.
Permanent life insurance has two policy subcategories: whole life insurance and universal life insurance. Both of these life insurance policies are self-explanatory: permanent life insurance policies, meaning the life insurance policies never expire as long as you are alive. The only real difference between a whole life insurance policy and permanent life insurance is regarding their cash value.
A cash value is a sum of money part of your life insurance policy that grows with interest over time. As you pay your life insurance premiums, a portion of that premium goes into the cash value. How complicated you want to make your life insurance cash value depends on if you go with whole life insurance or universal life insurance.
Who Needs Life Insurance?
Before you get into the process of calculating how much life insurance you need, it is worth asking yourself if you even need life insurance. Life insurance may not make sense for everyone as opposed to other insurances like auto or homeowners.
If you are single with no dependents, like children or a spouse, you may not need life insurance. You may already possess enough funds to cover final expenses and debts. If you have dependents but are fortunate enough to tuck away enough funds for them to provide for themselves and pay any expenses, you could very well self-insure, which makes the purchase of life insurance unnecessary.
But many are not lucky enough to be in that position. If you are the sole or primary provider for your family or others and have a significant amount of debt, such as a mortgage, they would have to cover in your passing, it would be best to look into purchasing a life insurance policy.
You may also want to consider a life insurance policy if you are a business owner. You can name your business as your beneficiary as means of offering financial support in the event of your passing.
How Much Life Insurance Do I Need?
The amount of life insurance coverage you need is made up of a variety of financial obligations you have either now or will have in the future. It is also determined by other personal factors such as health and age.
Here are some of the factors to take into consideration when calculating the perfect life insurance policy plan for you:
Probably the most obvious thing to consider with life insurance is being able to have your outstanding debts covered after your passing. This can include debts such as student loans, car loans, credit cards, mortgages, and personal loans. You will want a life insurance policy that covers any of those debts in full. Be mindful of interest, as well. Figure how much you would need to be able to pay off right now but tact on extra to assure full coverage.
Coverage of your annual income needs to be considered when shopping for life insurance policies. Your life insurance policy should be large enough to cover the yearly income you bring in, but you also need to factor in inflation. Whatever amount you think will be sufficient, add a little bit extra just to be on the safe side when it comes to calculating income.
Some of the first expenses your loved ones will face upon your passing are funeral costs. Over the years, funeral expenses have only increased, and you should figure out how to fit them into your life insurance coverage when looking for life insurance. Some details you have to consider are funeral home costs and the price of caskets. This isn’t the most pleasant topic to think about, but ignoring it could leave your family scrambling to find a way to pay for your funeral.
As has been stressed various times through this piece, your life insurance policy is to offer financial support for those who rely on you once you have passed. Due to this, you need to look at who you are providing for and factor that in when hunting for life insurance policies. This could be your own child, spouse, or parent who needs care. Increase your life insurance policy to include specific medical costs.
This one goes a little hand-in-hand with the aforementioned factor. For any child you have, it is best to assume that they will be going to college and will need some way to pay for their higher education. This includes the cost of tuition, boarding, textbooks, and any other miscellaneous expenses. When factoring this into your life insurance coverage, you should also keep in mind that tuition steadily increases over time.
Age And Health
Looking at your age and health will help determine both how much life insurance coverage you will need and what kind of life insurance policy you should purchase.
If you are purchasing life insurance when you are older, you may need less life insurance coverage and could possibly get away with just a term life insurance plan. The less life insurance coverage is due to the fact you probably have fewer debts and fewer dependents as opposed to someone younger.
As you are calculating how much life insurance coverage you need, do not forget to actually look at your budget. It is important to make sure that what you are paying for fits into what you can afford. If you want to bring your life insurance premiums down, try looking into discounts available through the insurance company you partner with. While you never want to be underinsured, you also do not want to break the bank over this.
Cost of Living
Be sure to consider the cost of living when figuring out your life insurance policy coverage. How much do you spend on groceries every year? What about clothes and restaurants? Maybe you even want to factor in streaming service subscriptions. The cost of living goes up over time, so make sure to factor all of this on top of the other determinants outlined above.
How to Calculate How Much Life Insurance I Need?
To get an idea of how much life insurance coverage you need and should purchase, you can manually calculate it. This may be a bit of a tenuous process as it requires you to pull exact numbers from your financial records, but the better you understand your financial position, the better insured you can be.
Calculating your life insurance coverage needs is a two-step process:
Add up your financial obligations
- Annual salary (multiply it by the number of years you wish to replace that income for)
- Mortgage balance
- Other debts
- Future expenses (ex. college tuition and funeral expenses)
- If applicable, replacing the cost of services provided for free by a stay-at-home parent
Subtract your liquid assets
This can include:
- Current college funds
- Any current life insurance policies
After doing the math, the amount you are left with is how much life insurance coverage you need.
Are There Methods of Calculating Life Insurance Coverage Amount?
If you want a more general idea of how much life insurance coverage you need, there are a few ways to do some quick estimations.
Just be aware that these numbers are only a rough idea of the life insurance coverage level you need or should get. They often do not take into account more specific parts of your financial position like debts and savings. While it certainly is a lot better than going in totally blind, using more precise calculations may be worth the time and effort.
Multiplying Your Income by 10
Many insurance experts suggest that when it comes to buying life insurance, you should buy life insurance coverage that is about 10 times larger than your income.
Essentially, all you do is take your income and multiply it. If you make $40,000 per year, you would want $400,000 in life insurance coverage ($40,000 x 10 = $400,000). While this is an easy way to calculate a life insurance coverage estimation, it does not take into account other factors like your savings and debts.
10 Times Your Income, Plus Factor in Children Care
This method takes the main idea of the previous method but adds on a bit of money to include children’s care costs.
For this, you could multiply your income amount by 10 and then add around $100,000 per child you have. This would mean factoring in life insurance coverage for their college tuition and other expenses. If you make $35,000 per year and you have one child, you would want about $450,000 in life insurance coverage ($35,000 x 10 + $100,000 = $450,000).
While this at least considers future child care costs and gets a bit more specific for life insurance coverage, it still fails to include other financial assets. Be cautious when using either this formula or the one mentioned above for computing how much life insurance you would need.
The DIME Formula
This formula gets a bit more detailed and takes just about as many assets and expenses as the manual calculation into account.
DIME is an acronym for debt, income, mortgage, and education. These are the four main components you need to consider while assessing how much life insurance coverage you should get.
This method can be completed as followed:
- Debt - Add up debts (do not include mortgage here, that will come in later), along with estimated funeral costs.
- Income - Figure out how many years your family would need your income support after you pass.
- Mortgage - The amount left on your mortgage.
- Education - Evaluate the future cost of sending your child (or children) to college.
Once you have pulled these factors, add them all up and get a better idea of how much life insurance coverage you will need. Still, keep in mind that while this is much more detailed than just multiplying your income, it does not cover everything. You may still want to buy a little bit more life insurance coverage than just the sum of the DIME formula.
Should I Use an Online Life Insurance Calculator?
If you would like to avoid doing your own math, some websites offer a free life insurance calculator.
These calculators have a short questionnaire that asks for some general information about you. This may include your age, your debt, and your annual income. After you complete it, you will have a rough idea of what kind of life insurance policy you should buy and how much life insurance coverage you will need.
While this is still not as accurate as manual calculations, it does make getting an estimation of how much life insurance should you get a little simpler.
Which Mistakes Should I Avoid When Figuring Out Life Insurance Coverage?
Life insurance, like any other kind of insurance, is a serious matter, and you want to make sure you are getting the absolute best life insurance coverage for the best price.
While this piece serves as a good guide, there are still some minor mishaps that can happen along the way.
Here are some tips to help you obtain the smartest life insurance policy for you
- Avoid skimping - Yes, higher life insurance coverage will increase your life insurance premiums, but you shouldn’t drop life insurance coverage just for a lower life insurance premium rate. Running the risk of being underinsured can mean disaster for your loved ones if they are not financially supported when you are gone. Also, remember to factor in inflation. Your income may rise, but so will expenses. The level of life insurance coverage you need today will not be the same decades from now.
- Consult loved ones about their life insurance policies - Family and friends are going to be some of your most valuable sources when it comes to life insurance policy shopping. If able to, talk to them about their life insurance policies. As paying customers, they can offer some unbias reviews and helpful advice about life insurance policy buying. By learning their needs, you may also be able to get a sense of just how much life insurance you will need.
- Shop around - It is very important to compare life insurance policy quotes from both local and national life insurance companies. You not only never know where you will find the best life insurance price but also who will offer the best life insurance coverage. Life insurance policies shift from one insurance company to another. Insurers have their own algorithms; go explore a little.
- Don’t focus solely on the price - Of course, we all want the cheapest life insurance we can find. No one ever wants another expense, but you still should never jump on the first life insurance policy with the lowest premium rates. Take time to evaluate the coverage and what kind of policy it actually is. You never want to jeopardize any of your valuables, whether it be your home or future financial coverage.
- Talk with your dependents - The “when I die” conversation is undoubtedly never one anyone wants to have, but it is vital in this circumstance. Your dependents need to know your plans and what they can expect to receive when you pass. You need to sort out expenses and coverage needs before the unfortunate occurs. It is a tough conversation to have but will be very helpful in the long run.
Is There a Required Life Insurance Minimum?
Unlike auto insurance, there is no required minimum amount of life insurance you must carry. But with that being said, if you find yourself providing for someone, whether it be a child or spouse, you should absolutely have some form of life insurance coverage.
As mentioned in a previous section, many recommend that you carry 10-15 times your income. That can be a good place to start, but personal factors will truly determine how much life insurance you need. It is hard to give a certain average of life insurance coverage as every person is different.
What’s The Best Insurance Policy For Me?
Life insurance policies are customizable because no two lives are the same.
Two people never hold the same expenses. If, for example, you have one child and spouse to support, your life insurance policy is going to look gravely different from a person who has four children to provide for.
It is best to sit down and really take time to look at the assets and financial obligations you have acquired over the years. You may even want to consider adding on life insurance policy riders. A rider is an addition to your policy that provides coverage for specific instances.
For example, if you add a disability waiver rider, in the event that you are disabled after an accident, your life insurance premium payments will be halted for a set period of time. Each person may call for different rides. They do cost more but can be really helpful if the unimaginable happens. It is hard to lay out what life insurance policy would be best for you, so the best you can do is follow one of the calculation formulas from above and make a strong, educated guess.
What’s Next Once I’ve Settled on Life Insurance Coverage?
Now that you have explored how to calculate life insurance coverage, you probably have some idea of what kind of life insurance would like to purchase.
Here are some steps you can take to secure your life insurance policy
- Research - Shopping around for life insurance is a good place to start. Compare quotes from all the life insurance companies you believe have a good life insurance policy for you. Once you find a company life insurance policy that is appealing, start looking into reviews from third parties to get a full understanding of the insurance company you are interested in. It may even be beneficial in the process to consult an insurance agent or broker. They will have more knowledge in the field of life insurance.
- Prepare for the phone interview and medical exam - After you submit an application for life insurance, you will have to do a phone interview and medical exam. It is possible to opt-outlay out of the medical exam, but it is generally expected of you to complete it. The phone interview centers around your life insurance company getting an idea of who you are and your medical history. The medical exam tells them how healthy you are. All of this is part of what makes up your annual life insurance policy premiums.
- Get a temporary life insurance policy - Reviewing your application can take a few weeks, and your life insurance policy does not become active until you make the first payment. Due to this, your dependents are left uncovered for many days. It may be helpful to look into getting temporary life insurance, so they have some protection while you wait for your life coverage to activate.