How Much Life Insurance Do You Actually Need?

While life insurance is rarely required, it is typically a consideration when starting a family or having loved ones who rely on you financially. In these circumstances, the amount of life insurance you require is directly related to the reason you are acquiring a policy. If you have a mortgage and are the primary breadwinner for your family, you'll need a significantly larger life insurance policy than if you merely want to cover your final expenses. A good rule of thumb is to obtain enough life insurance to cover all important foreseeable financial obligations, providing your family has access to your liquid assets.

How to Calculate the Amount of Life Insurance You Need

A good rule of thumb for determining your life insurance needs is to buy a policy with a death benefit of 5 to 10 times your annual salary. While this is a simple calculation, it is unlikely to reflect your actual requirements. The level of financial security your family requires fluctuates over time when children graduate from high school and debts are paid off.

A better rule of thumb is to tally up all of your current and future financial obligations, then deduct all assets that would be liquidated if you died.

How to Calculate Debts & Financial Obligations

Financial commitments are often classified as current debts, income replacement, and future expenses.

A mortgage, auto loan, credit card balance, and other personal loans are examples of current debts. You may not need to consider all of these debts when estimating your life insurance needs, depending on how your finances are organized. For example, if you have an outstanding mortgage, you should normally account for it in your life insurance death benefit since you don't want your family to have to relocate after your death. If, on the other hand, you do not live with a partner, your children have their own homes, and the current worth of your home exceeds the outstanding mortgage debt, you may not need to mention it.

It can be difficult to establish how much life insurance you would need as income replacement because an accurate amount would include an examination of your family's current costs, anticipated spending, and savings plan. You may get a rough estimate by combining the following figures together:

• Children: Estimate how much money you spend on children (the average is roughly $13,000 per child per year, though this value fluctuates depending on age). Multiply this quantity by the number of years until your children leave home.
• Spouse: Subtract your children's and mortgage costs from your annual household budget. Multiply this value by the number of years you think your partner will live. According to the Social Security Administration, a 35-year-old woman can expect to live to the age of 86, while a 35-year-old man can expect to live to the age of 82.

Because this is an approximation, the value you arrive at is likely to be higher than your family's real needs. You must, however, budget for your family's impending expenses. These could include the cost of sending your children to college, your spouse acquiring a new automobile, paying for an older parent's long-term care, or even contributing to the expense of a child's wedding.

Education expenditures are typically one of the greatest expenses that must be considered when getting life insurance. According to The College Board, the annual all-in cost of sending a child to college this year (including tuition, fees, and room and board) is:

• A public in-state college costs $20,090 per year.
• A public out-of-state college costs $35,370.
• $45,370 for a private, non-profit university

By summing your existing debts, income replacement needs, and future financial responsibilities, you may calculate the maximum amount of life insurance you may require.

How to Calculate Your Assets

The following stage is to total your assets and other sources of income. This amount will be deducted from your total financial responsibilities to establish your actual life insurance needs.

Include brokerage accounts, savings accounts, and any existing life insurance policies when calculating your current assets. Retirement accounts, such as a 401(k) or an IRA, should be avoided.

Also, if your family has many wage earners, increase their after-tax income by the number of years they anticipate to work. Include this in the total value of your assets.

What Kind of Life Insurance Do You Need?

Once you've determined how much life insurance you require right now, you should determine how long you'll require this level of protection. This is significant since the cost of a life insurance policy is proportional to the number of years it lasts, as you are more likely to die during the coverage period.

Determine if each financial obligation is time-sensitive or time-independent. A time-specific expense would only affect your family for a specified amount of time. For example, if your child is 12, you would expect their college expenses to be covered within the next ten years. A funeral is a frequent time-independent obligation because it is an expense that might occur at any time.

The majority of predicted expenses for most families are time-sensitive. If this is the case, we would recommend term life insurance because it is the cheapest type of policy and provides coverage for a certain period of time. Term policies can span in term from 5 to 35 years and give death payouts of up to $1 million.

If you have costs that aren't constrained to a set time frame, you have two choices:

• Buy term life insurance and save - Term life insurance is much less expensive than permanent coverage. If you can save enough money to merely cover the expense, simply purchase more term insurance for the period it will take to do so.
• Purchase permanent life insurance - While whole life insurance is the most prevalent type of permanent coverage, it is extremely costly due to the cash value investment component. If you simply want a policy that will cover all of your financial commitments for the rest of your life, guaranteed universal life insurance has the best rates with coverage that can continue until you're 121.

Whether you choose term or permanent coverage, ensure the rates are consistent throughout the policy's duration. If this is not indicated, the insurer may hike your rates, and you may find yourself unable to afford the coverage later, even if it is still required.

When Do You Need Life Insurance?

There are just a few instances in which you might require life insurance, but there are several reasons why you might want it. The following are the only times when life insurance may be required:

• If you are applying for a large loan and the lender demands coverage as collateral. In certain circumstances, the death benefit should be equal to or more than the loan. You can use a collateral assignment so that the lender only receives the outstanding debt and your beneficiary receives the remainder of the payout.
• If you are applying for a business loan or obtaining funding, one of the conditions of the investment is that you have key man insurance. This is a life insurance policy taken out on a founder or someone without whom the business would struggle to function. If you die, key man insurance compensates the firm, enabling funds to hire a replacement employee or repay corporate loans.

Aside from contractual obligations, many people get life insurance because it can provide financial assistance to their families and loved ones if they die. The following are some of the most common expenses that life insurance is used to cover: