How Much Life Insurance Should You Buy?

How to get the right life insurance amount

Maybe you know you need life insurance, but all you get is the policy through your employer because it seemed cheap.  Maybe it is cheap, but is it adequate?

Since you’re thinking about life insurance anyway, you might as well make sure your family has the right amount of coverage.  Insurance is all about displacing risks, so your fist job is to figure out why you need life insurance.

Seriously, let’s pretend I just asked the question, “why do you need life insurance, anyway?”  What would you tell me? Write it down on a scratch piece of paper.

Income replacement

You may have said you needed life insurance to keep paying for all your continuing and future expenses.  If you weren’t in your family’s life anymore, they still need your income to keep on living.  If this is what you wrote down, you need life insurance for income replacement.

Take your income, divide it by your beneficiary’s expected return on investments, and then subtract any assets he or she would have easy access to, like savings accounts, a second property, and so on.  That is roughly how much life insurance you need to replace your income.

But it’s just a start.  If you are the only income earner, don’t forget to calculate the cost of your benefits, like health insurance and 401k match.  Maybe your family would sell the big house eventually, but remember to include the carrying costs and the impact moving can have on social structures.

Pay off debts

If you wrote down that you need life insurance to pay off cars, credit cards, or eliminate the mortgage, you need life insurance for debt repayment.  Instead of buying credit life insurance or mortgage life insurance, you are usually better off getting your own regular life insurance policy to use for this purpose.

If you want a decreasing term-type protection to go down as your liabilities decrease, make your own.  With any type of life insurance where the life insurance amount remains level, you can always reduce it to the allowable minimum.  As you do, your premiums will go down, allowing you to snowball debt even faster!

Consider for a moment that there may be other expenses you’re leaving out.  Paying off debts is a great goal, but would the rest of your family’s income be sufficient to survive without those debts?  Final expenses can become expensive.  Beyond funeral costs, consider medical costs from terminal illness your family may be left with, and so on.

I’m just saying think it through.  It’s better to have a little too much life insurance than not enough.

Supplement retirement

But what if you are beyond that stage of your life?  You are looking forward to a comfortable retirement, but you aren’t sure you could meet your goal yet if one of you two died unexpectedly.

If this is what you wrote down on your sheet of paper, you need life insurance to fill the retirement gap.

Fortunately, this is easy to plan for.  You already have a good idea how much money you need saved for retirement and how many more years you have to go.  If not, now is a good time to figure it out.  Once you have your retirement number, subtract the amount you have saved up.  Now you know exactly how much life insurance you need and the how long you need it to last.

College savings

Some people buy life insurance to make sure they can send their kid to college, even if they won’t be around to see them graduate.  If that’s what you wrote down, there’s actually an easy way to calculate future college costs.

According to most experts, college expenses are going up by 5-8% each year.  Plan accordingly.  Once you know how much life insurance you need and how long that need will last, anonymously comparing life insurance quotes will be much easier.

Stay-at-home spouse

Just because someone doesn’t bring home an income doesn’t mean they don’t provide value to the family.  Consider the full financial impact of having to replace all the things a stay-at-home spouse or partner provides.

There are two ways to figure out how much life insurance for stay-at-home moms or dads.  The first one involves writing everything down and pricing it out.  The next is just having a conversation about how much you would realistically need.  The right number is usually somewhere between 1x to 2/3x the income of the other spouse or partner, but it’s a personal choice.  Communication is key here.

In the end

You might have a combination of these goals – and that’s okay.  Once you get a round number, talk with your loved ones to see if you should move it up or down.  If you have multiple goals, add your numbers together to get a starting point.  If your goals include income replacement, use that alone as your base line (You should be able to achieve all your goals if you replace your income, right?).

There are lots of other reasons you might need life insurance too.  Things like estate planning and business continuation often involve life insurance.  But these are the some of the most common reasons for life insurance.

Figuring out how much life insurance you need isn’t rocket surgery, but it does take a little time and effort.  First, figure out why you need life insurance, and then define that need in a little more detail.  Once you know your parameters, finding the right customized life insurance quotes anonymously is easy.

This is a guest post from Aaron Pinkston who created Clarifinancial.com to make buying life insurance easier and better.

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