How Much Life Insurance Do I Need?

How Does Life Insurance Work?

In return for paying premiums, life insurance provides a financial payout called a death benefit to your beneficiaries if you die while the policy is in force. You choose the amount of death benefit when you buy a life insurance policy. In addition to the death benefit, some types of life insurance build cash value you can access during your lifetime.

Types of Life Insurance

• Term life insurance lasts for a certain period, typically up to 30 years, with premiums that usually stay the same the whole time. If you die during the term, your beneficiaries receive a payout. Term life insurance is a flexible, affordable option for most people.
• Permanent life insurance lasts your whole life as long as you pay the premiums, which are much more expensive than term life premiums. In addition to a death benefit, permanent life insurance builds cash value that you can tap once it reaches a certain amount. The simplest type of permanent life insurance is whole life insurance; universal life insurance and variable universal life insurance are more flexible, but more complex, options.
• Group term life insurance is sometimes offered as an employee benefit, typically with premiums paid by your employer and the option to buy more coverage. Group term life insurance typically ends when you leave your job, but some plans let you convert the policy to individual coverage.
• Final expense insurance usually has a death benefit ranging from $5,000 to $25,000 and costs just a few dollars a week. Also called burial insurance, it's designed to cover end-of-life expenses but can be used for whatever the beneficiary wants.
• No-exam life insurance allows you to get insurance without undergoing a medical exam. It generally requires answering questions about your health and medical history or reviewing your medical records. Death benefits can range from $25,000 to $1 million.

Learn more: Which Is Better: Term or Whole Life Insurance?

How Much Life Insurance Do I Need?

There are several factors to keep in mind when determining the amount of life insurance you need.

• Your household financial obligations and debts: What are your total monthly household expenses, including mortgage or rent, health insurance, child care, utilities, and credit card, auto loan, student loan or personal loan payments?
• Your family's additional financial needs: Along with monthly expenses, are there future costs you want your life insurance to cover? This could include your children's college tuition and wedding expenses, for example.
• Your final expenses: These include funeral costs, any taxes your estate owes and the administrative costs of settling an estate. The Insurance Information Institute advises estimating at least $15,000 for final expenses.
• Your liquid after-tax assets: This includes your savings accounts, retirement accounts, pensions, any existing life insurance policies (such as group term life insurance) and estimated Social Security survivor's benefits.

Tip: Think about when your family will be able to access your assets. For instance, unless you have minor children, your spouse may not receive Social Security survivor benefits until after age 60.

Subtracting your financial obligations, debts, additional financial needs and final expenses from your liquid after-tax assets will give you an idea of how much life insurance you may need.

Learn more: When to Buy Life Insurance

How to Determine How Much Life Insurance You Need

There are several methods you can use to estimate your life insurance needs.

Multiply Your Income

Financial experts often suggest multiplying your annual income by 10, 20 or even 30 to figure out how much life insurance you need. When calculating your income replacement needs, be sure to consider non-wage compensation, such as health insurance or your employer's 401(k) matching contributions. (Stay-at-home parents should estimate how much it would cost to hire someone to provide services such as child care and housekeeping.) If you have children, you can add $100,000 per child for college expenses.

Example: If your income is $60,000 annually and you have one child, you would purchase anywhere from $700,000 to $1.81 million worth of life insurance coverage.

Use the DIME Formula

The DIME method determines your life insurance needs by adding up:

• Debt: Include credit card balances, auto loans, student loans or personal loans
• Income: Multiply your income by the number of years your family will need financial support
• Mortgage: Your outstanding balance
• Education: Estimate college and, if applicable, private school expenses for your children

Example: You have $50,000 in outstanding debts, make $60,000 annually, your family will need support for 20 more years, you owe $250,000 on your mortgage and you have one child who may need $150,000 for college expenses. Using the DIME method, you'd purchase $1.65 million in life insurance: $450,000 to cover your outstanding debts and college expenses, and $1.2 million to cover 20 years of your income.

Consider the Human Life Value Method

The human life value method bases your death benefit on your potential future earnings from now until retirement. Using the assumption that your income is likely to increase as you get older, you'd purchase the following amounts of insurance based on your age and income:

• Ages 18 to 40: 30 times your income
• Ages 41 to 50: 20 times your income
• Ages 51 to 60: 15 times your income
• Ages 61 to 65: 10 times your income

Example: If you earn $60,000 annually, you might choose a death benefit of $1.8 million, $1.2 million, $900,000 or $600,000, depending on your age.

Learn more: How to Save Money on Life Insurance

Why Is Life Insurance Important?

Life insurance can protect your loved ones from financial hardship after your death, providing the funds they need to pay their bills and manage debts. A life insurance payout can also be used to pay any taxes your estate owes and cover final expenses such as funeral costs.

Beyond providing for your family's day-to-day financial needs, life insurance can also be a way to pass on generational wealth or help your family achieve longer-term goals, such as paying off the mortgage or paying for college. Death benefits usually aren't taxable and are protected from creditors, so you can rest easy that the life insurance payout will go directly to your loved ones.

Finally, permanent life insurance that accumulates cash value can be a source of extra income in retirement. You can take a loan against the policy's cash value or withdraw funds directly (although this reduces your death benefit).

Learn more: What Is Life Insurance Used For?

How to Change a Life Insurance Policy

Your options for changing life insurance depend on the type of policy you have and the terms of your life insurance contract. Review your policies annually and reach out to your insurance agent to ask about adjusting your coverage or changing from a term life to a whole life policy.

You'll likely want to change your life insurance coverage when you experience a major life event, like marriage, divorce, the birth of a child, buying a home or paying off your mortgage. Keep in mind that increasing your coverage usually requires a medical exam.

If you need more coverage, buying an additional life insurance policy is another option. For example, if you purchased a term policy when you got married but have since had a baby and bought a home, you could add a new policy with a 20-year term to provide more coverage for your family until your child is grown.

Learn more: Reasons to Change Your Life Insurance

Frequently Asked Questions

The Bottom Line

Buying life insurance can protect your family's financial future, giving them the means to support themselves if you die unexpectedly. Working with an insurance agent can help you determine how much life insurance you need. Although price shouldn't be your only consideration, shopping around and comparing prices from various insurance carriers can help you safeguard your loved ones for an affordable price.

Life insurance companies in many states can check your credit-based insurance score when reviewing your application. Actions that help improve your regular credit score, such as making timely payments and keeping credit utilization low, may also help to improve your credit-based insurance score, which could save you money on life insurance premiums. Before applying for life insurance, it's a good idea to check your Experian credit report and FICO^® Score^Θ, which you can do for free.