According to research, only about 60% of people in the United States have some form of life insurance. Among those that do have coverage, one in five people doesn’t think they have an adequate amount.
Are you among either of these groups? Maybe you have a life insurance policy in place, but you’re unsure if it’s substantial enough to meet your current and long-term needs. Or, perhaps you don’t have any coverage at all.
Either way, it’s essential to ask the question, “How much life insurance do I need?”
While the answer is different for everyone, there are several factors to consider as you weigh your options. Today, we’re diving into the issues that can affect your policy level and dictate the coverage you require. Read on to discover the details you need to know to make an informed decision.
How Much Life Insurance Do I Need? The Short Answer
Before we get too deep into the specifics that comprise a life insurance policy, it’s essential to understand what this type of coverage is meant to protect. Unlike homeowner’s insurance or auto insurance, this policy doesn’t kick in right away. Instead, it’s designed to protect your loved ones financially upon your passing.
In this sense, you aren’t investing in life insurance for yourself, but your loved ones. Consider the debt burden they might be required to assume upon your death. Are you currently paying on a mortgage or putting a child through college? Who would shoulder this expense if your income suddenly is taken away?
How can you determine exactly how much your loved ones will require if left to assume your current debts? Let’s take a look at how to buy life insurance wisely using strategic calculations.
Step 1: Calculate Your Assets and Resources
To understand how much you’ll need to spend, you should first start by considering how much you already have.
In addition to your after-tax income, this also includes any liquid assets you possess. Liquid assets are those that can be quickly converted to cash if required. For instance, this might consist of your savings accounts, certificates of deposit (CDs), stocks and bonds, or money market funds.
In short, this is the total amount of money that your beneficiaries will be able to access upon your death.
Step 2: Determine Your Financial Obligations
Once you’ve calculated the total amount of assets you’ll be able to leave behind, it’s time to think about the expenses that you’ll go in your wake.
These don’t include things like cable subscriptions, industry affiliations, or any other expense that can be easily canceled with a phone call. Instead, these are usually substantial, long-term costs that you’ve been paying on for several years.
Your financial obligations include everything that your loved ones would need to pay for in the future. Unsure how to add up these numbers?
First, start with your expenses:
Before you investigate the other types of expenses that your family might incur, first consider the monetary support that you’re currently providing them. These will include both monthly bills and fixed costs.
For example, do you pay for the family’s groceries every month out of your income? If so, add the average cost of a supermarket visit to your list. What about the cable bill, phone bill, and utilities?
Or, maybe you cover everyone’s preventative medical expenses, along with annual family vacations.
While vacations aren’t necessarily fixed expenses, if your family has spent a week in the same beachfront rental every summer for 10 years, you might want to include enough money in your life insurance policy to allow that tradition to continue.
One of the most common expenses included in a life insurance coverage determination is that of raising a child. If your children are grown, and out of the house, this might not be a large factor for you. However, most industry experts maintain that the ideal time to purchase life insurance is in your 20s or 30s.
That said, many investors will be right in the thick of raising their children when they buy their first policy. How much money will your partner require to raise those children if you suddenly pass away? According to the U.S. Department of Agriculture (USDA), the average cost of raising a child from birth to 18 years of age is around $13,000 per year for a middle-income family. If you adjust for inflation, that price could rise closer to $15,000 annually.
Caring for Dependents
On the opposite spectrum of raising children, you should also consider the expenses that you might incur if you’re currently caring for an aging parent or plan to shortly. Any time there is an additional dependent under your roof, your necessary life insurance coverage could grow by hundreds of thousands of dollars.
It’s essential to account for the real needs that each dependent will require. For instance, your parents could require a significant number of home healthcare services, medical visits, and pharmaceutical costs. Or, they might be in good health and independent. Take these factors into consideration and add them to your total expenses.
In addition to those early-year expenses, you can’t forget to add the cost of your children going to college. For the 2019-2020 school year, the average cost of tuition and fees was around $41,500 for private colleges and $11,500 for state students attending a public college.
Calculate how many more years your children have until they reach 18 years of age. Multiply this number by $15,000 to get a rough estimate of their cost of care. Then, add in four years of college. While this number won’t be exact, it can help you understand the magnitude of what educational expenses can equal.
End-of-life expenses are ones that no one likes to think about but should be included in this calculation. A casket alone can cost between $2,000 and $10,000, and that isn’t including the fees incurred for embalming, burial vaults, grave liners, preservation processes, and other special services.
Allocate around $10,000 for these expenses, though understand that they can vary depending on the selections you make ahead of time. While you aren’t required to factor these costs into the amount of your policy, consider the emotional toll that your death would bring to your family. Taking care of the financial aspect of your burial now can help relieve them of any additional stress when that difficult time comes.
In addition to your future expenses, what about your current debts? If you were to pass away, most of these payments would still be due. If your survivors co-signed with you on any loans, they could be left responsible for covering all or at least a portion of the bill.
Did your spouse co-sign on your home mortgage? Or, did your child co-sign on their student loan? If so, they could end up bearing the weight of the entire financial burden.
It’s essential to leave them with enough money to keep making timely payments on those loans. That is especially the case if you secured one or all of those loans with significant, necessary collateral, such as your house or the family car. If they default on the investment in question, these items will be the first ones claimed.
Even if your loved ones don’t currently live in the mortgaged house or use the financed car, they might still wish to inherit them one day. For instance, your child could be married and living with their family in a different house but have plans to restore your homeplace for their children. In this case, they’ll need to make sure that creditors don’t bypass them and seize the property first to recoup any outstanding debt payments.
A few of the most common debts that you might be currently paying on include:
Add a line for the total amount of each loan (e.g. $450,000 for your home mortgage) and incorporate all of the numbers into your entire expense column. When you add together your current and future expenses, along with your total debt burden, you’re left with a final number that represents your general financial obligation.
Subtract your assets from that figure to determine how much your loved ones will be left to cover without your support.
Step 3: Factor in Your Age and Current Health
In addition to your income and expenses, the amount of life insurance coverage you require will also hinge on your age and current health.
One factor to keep in mind? In most cases, your life insurance rate will increase with your age. That’s why it’s smart to invest in a policy while you’re young and healthy, even if you hope that decades pass before it needs to kick in! In addition to your age, insurers will also consider variable lifestyle conditions when determining the appropriate amount of coverage you need, including your driving record.
Understanding the Different Types of Life Insurance
When determining the size of the policy you need and can afford, it’s essential to discern the difference between the two main types of life insurance. These include:
- Term life insurance
- Whole life insurance
As its name implies, term life insurance only lasts for a predetermined number of years. Once that timeline is up, the policy expires. On the other hand, whole life insurance will continue indefinitely, as long as you pay the premiums every year.
While the latter sounds ideal, keep in mind that whole life insurance usually is much more expensive in the long run than term life insurance. As such, most budget-conscious policy shoppers opt for term life insurance. If you need to lower the cost, even more, you can choose a smaller policy or a shorter time frame for the plan.
Filling the Gap
After you’ve calculated your financial obligations and your assets, what’s left is known as the “coverage gap”. This is how much money your loved ones will need after you die. It can help you determine the size of the life insurance policy you should purchase.
Understand that you can change your policy down the road. For instance, you can raise the amount if you add more dependencies, or lower it if your dependency number drops. An insurance rider allows you this flexibility, though this add-on provision can come at an additional cost.
Understand Your Life Insurance Needs
While life insurance might not be high on your list of conversation topics, it’s a critical discussion to have. You don’t want to leave your loved ones blinded by dollar signs and due dates when they’re still in the throes of grief.
While there’s no cut and dry answer to, “How much life insurance do I really need?” the above guidelines can help steer you in the right direction. When you know how much life insurance to buy, you can rest assured that your family members will be comfortable and taken care of as they navigate their new normal.
Are you looking for more personal finance advice related to insurance? If so, you came to the right place. Check out more relevant information on our insurance page.