How Much Life Insurance Do You Need?

Calculate Your Needs

Add up the immediate and long-term expenses your death benefit should cover, and subtract other income, as in the following example:

You may have heard that your life insurance policy should replace five to seven times, or as much as ten times, your annual income. However, this kind of rough estimate is no substitute for a thorough analysis of your needs. Your insurance agent can help review your life insurance options with you to be sure you buy a policy that’s right for you.

Immediate and One-time Expenses

First, you should determine what expenses the policy should cover. For most people, the death benefit should pay immediate costs related to your death, help meet your dependents’ daily living expenses, and set aside money for future needs, such as education. Of course, your dependents may need more or less, based on your existing assets, their own income and assets, and whether they’ll receive income from Social Security or other sources.

Keep in mind, though, that the life insurance policy that’s right for you at one stage of your life may not provide the coverage you need at another. For example, you may decide to convert a term insurance policy to a permanent policy to lock in lower premiums. If you have universal life, you may want to take advantage of the option of increasing your death benefit.

Dependents' Ongoing Living Expenses

When an insurance review is a regular part of evaluating your financial plan, you’ll be more likely to make changes when they’re appropriate rather than risk waiting too long to update.

Add or Subtract

A life insurance calculator can help you come up with a ballpark figure as you begin exploring your life insurance needs. But it can’t take you as an individual into account. You should modify the basic coverage the calculator suggests to come up with a more precise amount—by adding money for special purposes or subtracting things that don’t apply. Here are some things you may want to consider:

Some life insurance calculators list your mortgage balance as a one-time expense. If your dependents plan to sell the house at your death, you may want to provide a lump sum to pay off the mortgage. But if they’ll continue living in the house, you can include the mortgage payments in your living expenses calculation.

When you calculate your college fund contributions, you may not have to provide enough to pay for a full four years of college if your family invests some of the death benefit in a special education-savings account. And if your children are of widely differing ages or have extraordinary expenses—say, you’re supporting a world-class ballerina or a competitive golfer or tennis player in the making— you might want to take the extra step of calculating costs for each child separately.

Other Considerations

The way your beneficiaries receive the death benefit could also have an impact on the amount they need. While they may choose a lump-sum payment, other settlement options are built into the policy. For example, beneficiaries may receive a fixed amount based on age, paid monthly or annually for life, or an amount that is paid on a predetermined schedule over a fixed period, such as 10 or 15 years.

As you select a policy, it’s important to think about both the amount of protection you need and what the coverage will cost.

You also need to fit the premiums into your budget. If you buy a policy with premiums you can’t afford, you’re more likely to let the policy lapse, leaving your dependents’ financial security at risk. But if you buy too small a policy, you still leave your dependents’ security at risk.

Understanding Illustrations

Your insurance agent may show you an illustration of the account value that a permanent policy could accumulate over your lifetime assuming a certain set of conditions. These illustrations can give you an idea of the cash you could have access to if you terminated your policy to provide a source of retirement income or for some other reason.

These estimates can be helpful, but be sure to look at them closely. If an illustration is based on earning an interest rate that’s higher than the policy’s minimum rate, it’s probably a good idea to ask the agent to show you an illustration of what would accumulate if you earned only the minimum. Together those illustrations could provide a realistic picture of both a potential upside and a more limited downside.

Sweet Charity

For many people, life insurance is used to comfort and protect family. If you no longer need the policy for your family, you might consider naming a charitable organization as your beneficiary.

You might be able to donate more money through a death benefit than you could afford to give in your lifetime. There may be income tax benefits, too, if you assign ownership of your policy to the charity.

Be sure to consult with the charity about your gift, since organizations have different preferences. Some can afford to wait years to collect a death benefit, but others may prefer to use the cash value now.