The first step in buying life insurance is figuring out how much you need. When you consider the amount of life insurance that will best serve you and your family, it's smart to consider the policy as one piece of your larger financial plan. Without a big-picture plan, it's difficult to get a grasp on a precise figure that's best for you.

Ultimately, the precise amount of the life insurance policy you choose should ensure your family's needs and obligations are met. After all, life insurance isn't really for you. It's for them.

Why do people buy life insurance?

In 2020, the industry group LIMRA organized a survey to discover the reasons people choose to buy life insurance. Participants were allowed to choose multiple reasons. The results were quite interesting:

  • Funerary expenses: 84%
  • As a legacy or wealth transfer to survivors and heirs: 66%
  • As an income replacement for survivors: 62%
  • Additional retirement income: 57%
  • To pay off mortgage debt: 50%
  • To pay for other (non-mortgage) home expenses: 48%
  • As a tax-advantaged investment: 45%
  • To avoid estate taxes: 43%
  • To pay for college: 37%
  • For business purposes: 28%
  • To leave behind a charitable gift: 27%

The top reason for buying life insurance, paying for a funeral, might sound surprising. It makes more sense when you consider the average memorial and burial expense in 2021 ranges from $8,000-$13,000. In most cases, this is an unanticipated expense many families haven't saved up or otherwise prepared for. Ensuring your loved ones aren't struggling to pay a surprise four-figure bill while grieving, well, that's good planning.  

These survey results aren't presented as a guide or a suggestion for your own situation. Rather, consider them a list of all the possible goals you can ponder when settling on your own life insurance needs.

Simple methods for calculating life insurance needs

Apart from using our life insurance calculator, the simplest method for coming up with the total amount of life insurance you need only requires a pencil and a piece of paper.

Start with this formula:

(My financial obligations I want to cover) - (Other assets that can be used to pay those expenses) = My life insurance needs

That's a fine start! Here's where things get just a little more tricky: what exactly should be included in the "financial obligations I want to cover"?

Make sure to consider the following in your calculations:

Your income: In order to provide the equivalent of your income for your survivors, multiply your take-home (after tax) pay by the number of years you want to replace it.

For how many years? This is also a variable. You might consider how long you'd expect to be working (in other words, the number of years to retirement). Or you might instead consider the number of years you'd want to support your children or dependents. At what age do you expect them to be able to operate on their own, without relying on the bank of Mom and Dad?

Your mortgage: If your life insurance policy amount includes the balance of your mortgage, you can ensure your family can stay in their home. You can relieve any concerns about failing to make payments or having to move elsewhere. Consider also, if your income replacement already factors in your mortgage payment, you don't need to double-count this.

Other debts: Might you leave your loved ones with other debts like credit card bills, car payments, or student loans? If so, it's smart to include those amounts in your calculation. (At a minimum, any high-interest rate debt should be factored in.)

Paying for college: Even if you have other tuition arrangements like a 529, consider how much your children's degrees will cost. This can be a moving target. There's a huge range of tuition costs, from local state universities to the Ivy League schools. You may want to consult with your partner before settling on an amount that best suits your family's needs.

The most recent figures from the College Board are for the 2020-21 year:

  • Public four-year in-state: $10,560
  • Public four-year out-of-state: $27,020
  • Public two-year in-district: $3,770
  • Private nonprofit four-year: $37,650

The "other assets" category is a bit more straightforward and mostly deals with familiar numbers. Here's what to consider:

Existing life insurance: You might have a pre-existing policy. If so, include this in your calculations.

Savings: Assuming you want to leave your family's emergency fund intact, you might include investments as savings your survivors could use to pay off debts and living expenses. On the other hand, you might prefer your beneficiaries to have those funds available for their own retirements – if so, don't include your retirement savings in this calculation.

Education-specific savings: Like the previously-mentioned 529, any savings your family has earmarked for education can be included as an asset.

There you go: you now have an estimate for the total amount of life insurance you need. Yes, there are variables and unknowns. However, working through this process provides you with a big-picture overview of your family's financial situation and the role your life insurance can play in their financial security.

If this process is too cumbersome, there are some rules of thumb that might come in handy...

The simplest methods for gauging life insurance needs

Here are three techniques that are simple and straight-forward, although they neglect the nuances of the method discussed above.

  1. Multiply your income by 10
    This number changes, depending on your age (or the age of your youngest dependent). Financial advisors don't have an agreed-upon number, even to serve as a starting place.
    That's why we don't really recommend this method. However, it may be useful as a starting point for getting quotes and estimating the cost of life insurance.

  2. The DIME method
    The acronym DIME stands for debt, income, mortgage, and education. You simply add up the amounts for each of these four items.
    Debt: As outlined above, any debt you leave behind (that isn't forgiven at death).
    Income: Just multiply your current income by the number of years you want to provide money for your family. How long? Until all your dependents are independent, perhaps.
    Mortgage: Simply add your mortgage balance, so your family can stay in their home.
    Education: Add the amount of four years' tuition, room and board, and other expenses for each of your children. The College Board publishes data regularly: https://research.collegeboard.org/trends/college-pricing

    Compared to the more comprehensive technique we described first, the DIME method doesn't consider the assets and other savings your family has. Relying on these figures alone might leave you over-insured.

  3. The budget method
    Instead of calculating your needs, the budget method works backwards. What's the maximum amount you want (or can afford) to spend per month on life insurance?
    Once you have that number firmly in mind, you can shop for life insurance quotes that offer the maximum coverage for your family that remain within your budget.

The bottom line

Your life insurance needs are as unique and individual as you and your family. There’s no hard-and-fast rule to rely on when gauging your life insurance needs. The best approach is to consider your family’s overall financial situation, and how best to support them and show your love in the event a tragedy strikes. 

Squeeze can help with simple, straight-forward, no-nonsense online term life insurance quotes to help you plan responsibly. We can help you find the peace of mind you want and the coverage you need without overpaying. (Remember, it’s not for you – it’s for them.)