There isn’t a one-size-fits-all answer to this question, but there are ways you can gauge the amount of coverage you need. First and foremost, it’s important to think about the financial gap that your family would need to fill without you. Start by taking the amount of assets you have, subtract your current financial obligations, and that equals the minimum amount of coverage you need.
What is the right amount of life insurance?
According to CNN Money, a recommended rule of thumb for life insurance is to purchase 7-10 times your annual income in life insurance, but this doesn’t take into account your unique financial situation. A better approach is to take the total value of your available assets and subtract from that your financial obligations:
Current financial obligations - Assets = Coverage amount
Your calculated coverage amount represents the financial gap between your family’s funds and their anticipated expenses. The policy you purchase should cover at least this amount. With term life insurance, you typically have a choice in coverage amounts ranging from $250,000 to $1 million. The right amount for you depends on your particular needs, future goals, and your budget. Fortunately, it’s easy to find your ideal level of coverage.
What financial obligations and assets should I consider?
Financial obligations to consider:
A financial obligation includes any financial debt or commitment you’re liable for and owe to another party, such as:
- Your mortgage: The money your life insurance provides can ensure your family can continue making mortgage payments or pay off the mortgage entirely.
- Loan payments: This includes student loans, home equity loans, and auto loans that your family will need to take over.
- Credit cards and other debts: Make sure to factor in any outstanding or anticipated debts, including medical or dental bills (especially if your kids need braces).
- Ongoing childcare expenses: The average cost of raising a child from birth to age 17 is an eye-popping $233,610. That doesn’t include the cost of college, which ranges anywhere from $20,090 to $45,370 annually.
- End-of-life expenses: Funeral costs are typically around $10,000 or more, so it’s important to make sure your family has enough set aside to cover them.
- Legacy gift and financial cushion: While not an obligation, if you intend to leave something behind for your kids, grandkids, or a favorite charity, life insurance can help make sure the money is there. You can also add more coverage simply to give your family more savings.
Assets to consider:
An asset is anything of monetary value that you own, benefit from, or have use of to generate income, such as:
- Savings and investments: The money you accrued in your personal bank accounts, stocks, bonds, mutual funds, or any inheritance you received.
- Retirement savings: The money you invest for retirement usually through an employer or other organization (IRAs, 401(k) plans, Social Security).
- Any existing life insurance policies: Current policies that will be paid to your family if something happens to you.
- Replace your income
- Pay credit card or other debts
- Make mortgage payments
- Cover day-to-day expenses
- Cover cemetery and funeral costs
Other important factors to consider:
Here are some other situations and circumstances that could affect the amount of coverage you need and should be considered when purchasing life insurance.
Are you or your spouse a stay-at-home parent?
If something unexpected happens to a stay-at-home parent, paying someone to handle day-to-day tasks, such as childcare, meal preparation, transportation, grocery shopping, laundry, and more may be necessary. In terms of coverage amounts, buying a policy roughly half the size of the working partner’s policy is a good choice (most carriers will approve that amount based on the income of the employed spouse).
Do you have a group coverage plan?
Some people have group life insurance through the company they work for. But in most cases, it’s not enough to cover the average person’s needs. In fact, having only group life insurance leads to an average gap of $225,000 in needed coverage.
Some group plans give you the option to buy additional coverage to supplement your policy. These supplemental plans typically let you buy coverage up to three or four times your annual salary. Keep in mind that most people change jobs over the course of their careers and, in most cases, you lose coverage issued through your company when you leave.
How to balance coverage and costs
While buying enough life insurance is important, it’s equally important to buy only as much as you can afford. After all, the more coverage you buy, the more expensive your policy is. While life insurance is much less expensive than most people think, there are a few things you can do to lock in the best price.
- Don’t wait to buy: It’s better to buy sooner rather than later, since the cost goes up every year you get older. Plus, if you develop a health condition, getting covered will be even more expensive or you may not qualify for coverage at all. Life insurance gets more expensive as you get older, with premiums going up an average of 8% to 10% a year. The smart move is to buy more coverage now if you think you’ll need it later, so you can lock in a lower rate from the start.