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.
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:
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.
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:
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...
Here are three techniques that are simple and straight-forward, although they neglect the nuances of the method discussed above.
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.)
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Learn more3 simple methods to determine the proper amount of life insurance you should have to ensure that your loved ones are taken care of after you're gone.
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