Key takeaways
- Consider your debts, income, future expenses and savings when calculating how much life insurance you need.
- Some life insurance calculation methods are more precise than others.
- Recalculate your coverage needs following life changes, such as having a baby, buying a house or opening a business.
Consider buying life insurance if anyone financially depends on you. The death benefit can help your family continue to pay bills and maintain financial stability if you die and your income stops.
There are several ways to determine how much life insurance you should buy. Securing life insurance now can help ease the burden on your family in the future, even if it forces you to answer difficult questions about your financial obligations and your family’s life without you.
Factors that affect how much life insurance you need
When calculating how much life insurance to buy, take stock of your family’s expenses, assets, income sources and financial goals. Some key factors to consider:
Outstanding debts
Take inventory of large debts that would pass to your loved ones if you die, such as:
- Mortgage
- Car loans
- Credit cards
- Private student loans, if not discharged upon death
Life insurance can help your family pay these bills if you die and your income stops. For example, purchasing at least enough coverage to pay off a mortgage can ensure your family can cover the monthly payment.
Replacing your income
One of the main reasons to get life insurance is to replace your income after you die. Consider your family’s everyday expenses, such as groceries, utilities, child care and transportation.
When calculating your life insurance needs, think about how many years’ worth of income you’d like to replace, accounting for inflation and anticipated income increases.
Future needs like college or final expenses
Consider other expenses you’d like to cover with a life insurance policy, such as education expenses for your children and funeral and other final expenses for yourself.
For example, do you want to buy enough life insurance to pay the full estimated college costs for each of your children or just a portion of these bills? You can find average college costs from the College Board’s Trends in College Pricing study.
If you’re factoring in funeral costs, consider the type of arrangements you’d like to provide funds for. The median cost of a funeral with viewing and burial is $8,300, according to the latest data from the National Funeral Directors Association.
Savings or existing life insurance
Consider existing funds that could help cover these costs, such as your savings and existing life insurance policies. Keep in mind that group life insurance you have through work likely ends if you leave or lose your job.
5 methods for estimating how much life insurance you need
There is no one “right” way to calculate how much life insurance you need, but there are several methods that can give you a good idea of how much coverage to buy.
1. Financial needs minus existing funds
A simple examination of what you want to cover, minus existing funds, can lead to a good estimate of how much life insurance you need:
- Add up the costs for what you want life insurance to cover. This could include income replacement for the years until you retire, children’s tuition expenses, large debts like a mortgage and funeral costs.
- Subtract funds your family already has that would be used toward these expenses if you die.
- The total is your life insurance need. .
2. The DIME method
The DIME method life insurance calculation focuses on where your money goes.
Add up your debts, remaining mortgage balance and money you’d like to set aside for your children’s education. Then multiply your income by the number of years you’d like to support your dependents. Add those sums together to determine how much life insurance you need.
- Debts
- Income
- Mortgage
- Education
The DIME method falls short in some areas. It doesn’t take into account existing savings and life insurance that your family could use. The DIME method also doesn’t factor in expenses like funeral costs, so if you use this method, be sure to include any additional costs you’d like to cover.
3. Income x 10
A simple rule of thumb for calculating life insurance needs is to multiply your annual income by 10. If your annual income is $100,000, for example, you’d need $1 million in life insurance.
However, this method is very imprecise. Two people with the same income level might have very different life insurance needs—a sole breadwinner with young children might need more life insurance than someone with a working spouse and grown kids. Working with a financial adviser can help you evaluate your unique situation and adjust as necessary.
This method also doesn’t account for the cost of education or child care. Consider adding in the estimated cost(s) per child to your life insurance amount, based on the most recent expense data available.
4. Income x 15
Tim Maurer, a certified financial planner and chief advisory officer at SignatureFD in Atlanta, recommends multiplying your income by 15 as a simple method that can give you a good start when estimating your life insurance needs.
The reason: If you invested that amount and earned 5% per year, the earnings would be slightly less than your annual income. (Multiplying your income by 20 would provide the same income, but Maurer uses the smaller number because your family will likely have fewer expenses if you die.)
“The reason I recommend 15 in most cases is there’s going to be a reduction in income needs simply because you’re not there any more,” he said.
For example, if your income is $100,000, multiplying it by 15 will get you $1,500,000. If your heirs invested this lump sum and earned 5% per year, that would give them $75,000 in income per year—close to the amount they might need to cover their reduced expenses after you die.
He helps clients do a more detailed calculation based on their specific needs, but this method gives them a solid start. “I’ve tried to boil things down to the simplest essence,” he said. “I don’t want there to be too many impediments to getting the life insurance they need.”
He recommends rounding up the amount rather than worrying about precision because term life insurance tends to cost a lot less than people expect. For example:
- A healthy 30-year-old woman would just pay only $129 more per year to increase her coverage from $500,000 to $1 million on a 20-year term policy, based on our analysis of term life insurance rates.
- A 30-year-old man would pay an extra $174 per year to add the extra $500,000 of coverage.
A study by Limra, an insurance research organization, found that when asked to guess the premium for a $250,000 20-year level term policy for themselves, healthy adults ages 18 to 30 overestimated the median cost by 10 to 12 times the true cost.
5. Human life value
The human life value calculation bases your coverage needs on your anticipated lifetime income or worth rather than your expenses and financial goals. Start with your current after-tax income and estimate how much it will increase through time until you reach retirement, then buy enough life insurance to cover that amount. Consider the rate of raises or cost-of-living increases to your income in the past when deciding how much to increase your income figure through time.
Pros and cons of life insurance needs calculations
Use a life insurance calculator for more accuracy
A life insurance calculator can help you estimate your insurance needs more precisely, and some can also show how interest and inflation can affect your future expenses.
Most life insurance companies have free online life insurance calculators that use different assumptions when estimating a life insurance need. Try several calculators to see how they align with the factors you decide are important. For example, does it include future college costs for children? There’s no one right answer, you just need to consider what is important to you.
It’s even better to work with a financial professional who can help you figure out how to incorporate life insurance into your larger financial plan to make sure your family can continue to reach their long-term goals.
How do I adjust my coverage amount as my life insurance needs change?
It’s a good idea to recalculate your life insurance needs every few years or whenever you have major life changes, such as a new baby, house or job or if you get married or divorced. If you determine that you need more life insurance after you bought a policy, you have some options:
- Buy another life insurance policy to supplement your original coverage. However, as you age or develop health issues, a new policy will cost more.
- Ladder life insurance policies. Laddering life insurance involves buying multiple policies with different coverage amounts and lengths to address changing coverage needs over time.
- Convert term life to a permanent insurance policy if you decide you want extended coverage and you’re within the term life conversion window. Your life insurance company will let you know what types of life insurance are available for conversion at the time you convert.
- Increase the death benefit (with certain policy types). With whole life insurance, you could use any dividends earned to buy paid-up additions, which increase the death benefit without changing your premiums (not all whole life policies earn dividends). With universal life insurance, you might be able to increase the death benefit up to certain limits. Ask your insurance company or your life insurance agent or broker about your options.
Matching your policy with your timeframe
Consider why and how long you need life insurance when deciding how much life insurance you need. This can also help you weigh the value of term vs. whole life insurance and other types of permanent insurance in the context of your own financial goals.
Term insurance, has fixed premiums for 10 to 30 years (and sometimes longer), works best when you need life insurance for a finite time period, such as:
- You’re buying life insurance to help pay your family’s expenses until your kids graduate from college and are on their own.
- You want to provide money to cover the remaining balance on a 30-year mortgage.
- You want to provide income for your spouse or family until you retire.
You can get a term insurance policy to match your timeframe.
Permanent insurance, such as whole life or universal life insurance, works well if you need life insurance for longer than 20 or 30 years, for example:
- You want to use life insurance for business planning, such as leaving your business to one child and life insurance money for the other child.
- You want to leave a legacy for your adult children or a charity.
- You have a pension with payments that will stop when you die, and you want to provide income for your spouse.
- If you have a disabled dependent who will always need financial support and you are buying life insurance for special-needs planning.
The younger and healthier you are when you buy life insurance, the lower your premiums will be. Premiums for permanent life insurance policies tend to be much higher than they are for term insurance, so you might want to consider getting a combination of term and permanent coverage at the beginning and gradually shift to more permanent coverage through time, said Keith O. Moeller, founder and private wealth adviser with Moeller Advisory Group, Northwestern Mutual in Minnetonka, Minn.