How much life insurance do I need?

Life insurance may be a valuable financial tool for many people. However, with all the different types of life insurance policies and varying levels of coverage, selecting the right life insurance policy for your needs—and the right amount of coverage—may be challenging. Some information that might help you determine how much coverage you need includes your current assets, income, debt, your number of financial dependents and your family’s lifestyle. If you’re looking to understand what life insurance coverage limit would be right for your needs, Bankrate’s insurance editorial team has provided a few tips to help you get started. You may also want to speak with a licensed insurance agent or certified financial planner before purchasing a policy to ensure it is the right policy to meet your financial goals.

What is life insurance?

Life insurance provides a financial payout to one or more beneficiaries of your choosing in the event of your death as long as you pay the premiums and the terms of the policy are met. Depending on the type of policy, life insurance will cover end-of-life expenses — such as a funeral or outstanding debts — or will provide compensation to sustain dependents’ quality of life or future financial needs.

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The amount of coverage you need depends on many factors, including your age, income, mortgage and other debts and anticipated funeral expenses.

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Whole life insurance combines life insurance with an investment component.

• Coverage for life
• Tax-deferred savings benefit if premiums are paid
• 3 variations of permanent insurance: whole life, universal life and variable life include investment component

Term life insurance is precisely what the name implies: an insurance policy that is good for a specific term of time.

• Fixed premium over term
• No savings benefits
• Outliving policy or policy cancellation results in no money back

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Who needs life insurance?

Life insurance can be a good idea for many people, not just those supporting families or spouses. While life insurance can provide financial stability in those instances, people have many different needs for life insurance. For families, life insurance can provide income replacement and security. High-net-worth individuals might also benefit from life insurance for completely different reasons. For instance, you might purchase a policy in order to cover estate taxes or business succession planning. Because of these key differences in why people take out life insurance, how much life insurance you should have varies from person to person.

How much life insurance do I need?

Some of the personal factors that determine how much life insurance you need include:

• Your age
• The ages of your spouse and children
• Your income
• Your mortgage and other debts
• Future major expenses for your children and/or spouse
• Burial costs and other final expenses

Before you take out a life insurance policy, consider what your goals are and what financial obligations would fall on someone else’s shoulders if you were to pass away unexpectedly. For example, if you’re a business owner, you might use life insurance to financially protect the future of the company you built and the employees who rely on you. On the other hand, if you have a spouse and dependents who depend on you financially, you might want enough life insurance to cover the loss of your income and ensure they can afford to remain in their home even if you unexpectedly pass away.

If you don’t have dependents or they are self-sufficient, you might not need as much coverage, but you may want to pay for funeral expenses or leave a financial gift. Take time to consider what you want your insurance policy to accomplish before you determine the amount of coverage.

Calculating your life insurance needs

There are several strategies that can help you figure out how much life insurance to purchase. You might choose to speak with a certified financial planner who can assess your financial situation and make a recommendation based on your family’s potential needs. You can also use a free life insurance calculator to give you a general idea of how much coverage may be necessary for you.

Another option is to use one of the popular models devised by insurance companies and financial experts. Here are three common approaches that might help you pick a life insurance coverage limit:

1. The DIME Formula (and 10 Rule)

The old “how much life insurance do I need” rule of thumb was to take your income and multiply it by 10. This was the industry’s standard for many years. However, this fails to account for several things.

Most notably, it does not take into account your family’s living expenses. This could vary wildly if you have one child or four. Moreover, it does not account for single-income families.

As grim as it sounds, it’s important to ask yourself what would happen if you and your partner both die and only one has coverage? The 10 Rule left many questions unanswered. In its place came the Dime Formula, which takes into account the following:

• Debt and final expenses: Come up with a solid number based on all the debts you owe, and include the costs of final expenses for each parent.
• Income: For income, a good rule of thumb may be to think about how many years your family would need income for in your absence. Multiply the number of years by your annual income.
• Mortgage: Include the total amount owed on your mortgage and the property taxes assessed. Similar to income, think about how many years your family would need the money to cover property taxes, then multiply your annual tax total by those years.
• Education: Determine the total cost of educating each of your children through their remaining years of school, including college.

Once you come up with that final number, you might want to consider doubling that for both parents. That way, if something were to happen to both you and your partner, your children and other financially dependent family members would have sustainable income well into the future. Alternatively, each spouse could complete the Dime Formula independently for their own life insurance needs.

2. Shortfall calculation

The shortfall approach works backward from the annual income you would want to leave your spouse and family for X number of years. After you decide on this target number, subtract all other sources of annual income that will be available to them, such as your retirement accounts, pension, savings, your spouse’s salary and Social Security. The resulting number is the shortfall you’ll want to replace with life insurance.

When using this method, it’s also important to include all of your assets. If you’re starting to save for retirement, for example, you’ll likely have more assets in the future than you do right now. A life insurance policy may need to account for those future earnings as well.

Factors to consider when buying life insurance

Buying life insurance is a process that typically requires self-evaluation to build the right policy. Considering these factors may also help you narrow down how much life insurance you need:

• Your age: Life insurance premiums generally increase with age. Even if you don’t currently have any dependents, getting a life insurance policy while you’re young may be more cost effective in the long run.
• Age of spouse and children: This helps you estimate how many years of income replacement financial dependents would need if you passed away.
• Mortgage and debts: When choosing a life insurance coverage limit, you’ll likely want to account for your home mortgage, car loans, student loans and other debts into your decision. Most debt does not disappear when you pass away, so your family members would likely become responsible for making the payments.
• College expenses: Educational expenses can be pricey. If you want to support your children and spouse through their future education, you’ll likely want to consider how many years of school they may pursue and the rising cost of education.
• Your current income: If you have no outstanding debt, no major future expenses (like college tuition) and have a healthy savings account, you may not need to replace your full income.
• Funeral expenses: The average cost for a burial or cremation, funeral and related expenses runs around $7,000. You may want to purchase enough life insurance to cover those end-of-life costs.

Choosing your life insurance policy

In addition to deciding how much coverage you need, you’ll also need to decide what type of life insurance is best for your needs. The two main types of life insurance are term life insurance and permanent life insurance. Under the umbrella of permanent life insurance, there are several different policy types, like whole life insurance and universal life insurance.

Term insurance is just that—a life insurance policy that covers you for a set term or period of time. Most term policies are available for 10, 20 or 30 years, although you might find providers that offer shorter or longer terms. Term policies are typically the cheapest type of life insurance and rates are usually fixed for the entire term length.

Once the term is up, the policy expires unless you choose to renew the coverage or convert it to a permanent policy, if available. Note that utilizing either the renewing or converting option will increase the premium.

Permanent life insurance goes beyond a period of time, covering you financially as long as you continue to pay your premium. Since it potentially offers lifetime protection under most circumstances, permanent life insurance typically has more expensive premiums. However, permanent life insurance also has the advantage of cash value. As you make your premium payments, your cash value earns interest. You can usually withdraw or borrow from this account once you reach a minimum threshold as defined in your policy.

To help you decide which type of insurance might be better for you, consider what you’re using the life insurance for. For example, families might prefer a term policy since it can cover large financial responsibilities that won’t last forever, such as college tuition or a mortgage, while permanent insurance might be a better fit for someone wanting to pay for end-of-life expenses or estate taxes.

While cash-value life insurance products do offer some benefits, returns may fluctuate depending on your policy type, so it may be best to speak with a licensed financial professional before purchasing a policy with a cash value component.

So, which policy is right for you? Your individual circumstances may provide the best guidance in dictating whether to choose a permanent policy, term insurance or a combination.

Frequently asked questions

• • Does everyone need life insurance?

    Not everyone necessarily needs a life insurance policy. If you have substantial savings, can cover end-of-life expenses and don’t have dependents who are relying on you financially, you might consider whether or not you truly need a policy. Before you make your decision, you might want to speak to a financial advisor.

  • What is the difference between term and whole life insurance?

    The main difference between term life and whole life is the length of time you’re covered and the cost of coverage. Term life insurance provides coverage for a set period of time, typically between 10 and 30 years, and is often far less expensive than whole life. Whole life insurance does not have an end date like term life insurance does. As long as you keep paying your premiums and follow the carrier’s requirements, your whole life policy should remain in force until you pass away.

  • Do I need life insurance riders?

    Life insurance riders could offer flexibility in personalizing your life insurance policy. If you’re wondering how to choose life insurance riders, consider starting by exploring the options different life insurance companies offer. From there, you could also speak with a licensed life insurance agent to determine which ones may help build the best life insurance policy for you and your family.

  • Can you have more than one life insurance policy?

    Yes, you can have more than one life insurance policy. Purchasing multiple policies may be strategic, like in the case of laddering your life insurance (a process that involves stacking multiple term policies). However, before you purchase more than one life insurance policy, you may want to review the potential benefits and drawbacks of this strategy and speak to a licensed life insurance agent to see if it could be right for you.

  • How do I find the cheapest life insurance?

    Many life insurance companies sell quality policies designed to meet your life insurance needs and fit your current budget. To find the cheapest life insurance, get quotes from several insurers to compare. Make sure you are comparing similar products and the same amount to get the best (and cheapest) life insurance. Unlike other types of insurance, like auto insurance, life insurance premiums might not vary as much between carriers.