How Much Life Insurance Do I Need?

Roughly 40% of adults in the United States don't have life insurance, according to a study conducted by LIMRA and Life Happens. Many people understand the importance of coverage but feel overwhelmed at the prospect of shopping for it. Figuring out how much life insurance you need is one obstacle that may deter you from seeking coverage, but you can easily determine the right policy by using established calculation methods.

How Much Life Insurance Do I Need?

How much life insurance you need depends on numerous factors, including:

Your age
What share of the household income you provide
What financial resources would be available to your family after you die
Whether you have children who still need to complete higher education
How much debt you owe
Whether your estate will be subject to estate tax after you die

Answering these questions allows you to begin exploring your insurance needs. You can use your responses and life insurance needs calculation methods to determine the policy size that's right for you.

Reasons to Buy Life Insurance

Understanding your own reasons for wanting to buy life insurance can give insight into how much you need. People may choose to buy life insurance to:

Pay for their burial and their final expenses
Increase their retirement income
Reduce the tax liability of their heirs when transferring wealth after death
Settle debts, such as a mortgage
Take the place of lost income
Cover home expenses
Finance higher education
Protect their businesses
Create opportunities for charitable gifting

Methods of Calculating Life Insurance Needs

Multiple calculation methods are available for determining how much life insurance you should buy. Consider using each one outlined below to arrive at a figure. You can then compare the results and think about your reasons for purchasing life insurance to figure out what size policy to shop for.

Traditional Method

The traditional way to calculate life insurance needs is to add up all of the financial obligations that you wish to cover and then subtract the total amount of assets that you have. To complete the calculation, follow these steps:

Income supplementation. If you wish to replace your income for your family, multiply your current annual salary by the number of years that you would like to provide it. For example, if you make $50,000 per year and want to provide financial security for your family for 20 years, you would multiply 50,000 by 20.
Mortgage payoff. Determine the remaining balance on your mortgage if you'd like your life insurance policy to pay it off.
Total debts. Add up the total amount needed to settle any other debts that you may have, such as credit cards or medical bills.
College costs. Estimate the total cost of college for your children if you want your insurance to cover it. The National Center for Education Statistics reports that the average annual cost of attending a four-year college is currently around $28,000 at public institutions and $45,000 at private institutions. Bear in mind that the cost of tuition increases each year. You may want to round up by $10,000 to ensure coverage.
Funeral expenses. Determine your expected funeral costs. The National Funeral Directors Association states that the median cost of a funeral with a viewing and burial is around $8,000 and the cost for cremation is approximately $5,000. If you own a separate burial insurance policy or have prepaid for your final expenses, you can skip this step.
Total obligations. Add up the figures for steps one through five. This number represents your total financial obligations.
Consider insurance. Subtract the value of any other life insurance policies that you have. Don't include supplemental life insurance provided through your employer in case you leave your job in the future.
Account for assets. Deduct the total value of your 401(k) plan and any other savings accounts or investments that you may have unless you don't want your beneficiaries to use that money to cover expenses.
Factor in college savings. Subtract the total value of any 529 college savings or other college savings accounts that you have for your children if you included college tuition in your calculations.

The figure remaining is the amount of life insurance that you need.

Income Multiplication Method

Some people prefer to use the income multiplication method to determine their life insurance needs. With this method of calculation, you multiply your annual income by a certain factor. Unfortunately, experts don't agree about what that factor should be. The South Carolina Department of Insurance suggests a factor of 5 to 7.

DIME Method

The DIME method focuses on debt, income, mortgage and education to calculate life insurance needs and doesn't consider any assets you have that your family can use after your death. To use this method, add up:

Your total amount of debt
The total amount needed to replace your income
The outstanding balance on your mortgage
The total cost of four years of college for your children

What Percentage of My Income Should I Spend on Life Insurance?

Some life insurance companies advise that you should spend 6% of your monthly income on life insurance premiums. This method of calculating your life insurance needs ignores the fact that premium rates vary. Your age, health, lifestyle, hobbies, driving record and geographic location play a role in determining the size of your premium. If you're classified as high risk, your premiums may be expensive. Basing the size of your policy on the premium price could leave you underinsured.

What Is Better: Term or Whole Life?

Term and whole life insurance policies both have advantages and disadvantages. You'll need to weigh the benefits and drawbacks to determine which is right for you.

Term life insurance:

Often has lower monthly premiums
Allows you to get more insurance for a smaller premium
May be available without an initial medical exam
Gives you the flexibility to easily increase coverage or change policies over time
Doesn't build up cash value
May require a medical exam prior to renewal
Can grow more expensive each time that you renew

Whole life insurance:

Remains in place for your entire life
Accumulates a cash value
Pays a guaranteed amount to your loved ones
Usually requires an initial medical exam only
Offers fixed monthly premium payments that won't change over time
Is usually more expensive than term life
Can't be modified or adjusted in the future