How to Determine How Much Life Insurance Is Needed

Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations.

One of the first steps to buying life insurance is by pinpointing how much you will need.  The best way to approach a life insurance purchase is as part of a larger financial plan. A financial advisor can help you see gaps and strengths in your current situation and where you're headed.

Your decision on the best policy amount and type of policy could change considerably after seeing where life insurance will fit into the big picture for you and your family.

Why Do People Buy Life Insurance?

Covering funeral and final expenses is the No. 1 reason people buy life insurance, according to a 2020 survey by LIMRA and Life Happens, both industry-funded groups. (People could choose multiple reasons.)

•  Burial/Final expenses: 84%

•  Supplement retirement income: 57%

•  Transfer wealth: 66%

•  Help payoff mortgage: 50%

•  Replace lost wages/income: 62%

•  Home expenses: 48%

•  Tax advantaged investment: 45%

•  Estate taxes: 43%

•  Pay for college: 37%

•  Business purposes: 28%

•  Charitable gift: 27%

The need to provide loved ones with financial security has heightened since the pandemic. A recent LIMRA survey found that 44% of households said they would face financial hardship within six months if the primary wage earner were to die prematurely. For 28% of households, financial hardship would hit within one month.

The Life Insurance Gender Gap

There is a substantial gender gap in life insurance ownership. While 58% percent of men have life insurance coverage, just 47% of women have a life insurance policy, according to the 2021 Insurance Barometer Study by Life Happens and LIMRA, insurance industry groups.

And when it comes to men and women who have life insurance, perception does not always meet reality. Most Americans (93%) say men and women should have equal life insurance coverage, according to a March 2021 USAA life insurance survey. But in relationships between men and women where both partners have life insurance, nearly one in three women say their partner has more coverage.

USAA's survey also found that 81% of men say they have taken steps to prepare their family's finances in the event something unexpected were to happen versus 72% of women.

Calculating How Much Life Insurance You Need

Here's an easy-to-use calculator to help you determine how much life insurance you need.

How much life insurance do you need?

Answer simple questions in our 3 step process

How much annual income would your dependents need?

How long would your dependents need financial support?

2/3

Let's calculate your life insurance need

How much debt do you need to pay off?

If you want to help with the cost of college tuition, how much would you like to cover?

How much do you want to add for burial expenses?

3/3

Let's calculate your life insurance need

How much savings do you have?

If you already have life insurance, enter the total coverage amount

Details that you have entered

How much annual income would your dependents need?

30,000

How much debt do you need to pay off?

160,000

How long would your dependents need financial support?

16 years

If you want to help with the cost of college tuition, how much would you like to cover?

160,000

How much do you want to add for burial expenses?

160,000

How much savings do you have?

160,000

Enter total coverage amount of existing life insurance

160,000

Now that you have an estimate of your life insurance need, you can start comparing quotes

Your savings and/or current life insurance total more than your needs. In this case, you may not need life insurance. If you want to exclude your savings or life insurance from the assets your family could spend, please lower the amounts input.

Recalculate

Basic Life Insurance Need Calculation

You can also determine your life insurance need with a pencil, paper and this basic equation:

[Financial obligations you want to cover] – [existing assets that can be used toward bills] = Your life insurance need

Here's what you might include in "financial obligations you want to cover":

•  Income replacement: Multiply the salary you want to replace for the number of years you want to replace it. You want this income replacement to cover current and future expenses.

•  A mortgage: You can include the balance of a mortgage so your family can stay in their home without fear of losing it. If income replacement (above) would already cover mortgage payments and other expenses, no need to add more mortgage money.

•  Other large debts: Would your family struggle with other large debts if you passed away unexpectedly? If so, add those in.

•  Children's college tuition: Add tuition money to ensure your children can pay for college if you were no longer around.

Here's what you could include in "existing assets that can be used toward bills":

•  Existing life insurance: If other life insurance is already in place to provide a financial cushion, subtract that amount. Be careful about relying on supplemental life insurance from work though—since it doesn't go with you if you leave a job, you can't be sure you'll have it later on.

•  Savings: Subtract any savings your family would use to pay expenses. You can include retirement savings such as a 401(k) plan, or leave it out of your analysis if your beneficiaries want to preserve that amount for retirement years.

•  College 529 savings: If you have a 529 account with money in it for your children, you can subtract it from your life insurance needs.

•  Funeral expenses: Many people want life insurance to cover funeral and final expenses. If this cost isn't part of a larger policy, some people buy burial insurance.

Other Methods for Calculating Life Insurance Needs

You may run across other methods for calculating how much life insurance you need. These usually include:

Multiply Your Income by 10

Or by 5. Or by 17. This rule of thumb is hard to pin down. We've seen many numbers attached to it. And it likely won't help you pin down an appropriate amount of life insurance. Better to look at your total needs and subtract the assets your family could use if you passed away.

The DIME Method

DIME stands for debt, income, mortgage and education. The method has you add up these amounts:

•  Debt: How much debt would you leave to other people? This could include credit card debt and student loans that aren't forgiven at death.

•  Income: Multiply your income by the number of years you want to provide income replacement for your family. Some sites advise using the number of years until your youngest child turns 18, but we all know that kids often need financial help longer than that.

•  Mortgage: Add your mortgage balance to your running total.

•  Education: Add an amount that covers tuition, room and board for each of your children who will go to college. The College Board regularly publishes trends in college pricing.

The DIME method is a good start for calculating a life insurance need, but it ignores existing financial resources that your family might tap for expenses. By itself, it could leave you over-insured.

Compare Life Insurance Companies

Compare Policies With 8 Leading Insurers

Frequently Asked Questions

What's a good calculation for how much life insurance you need?

Use this formula:

Financial obligations you want to cover (such as your annual income for a certain number of years)

-Minus
Existing assets that can be used toward obligations (such as savings)

= Equals

Your life insurance need

Once you have an idea of how much life insurance you need, you can start comparing life insurance quotes

What are some tips for buying life insurance?

When you're buying life insurance, it's a good idea to look at more than just the price. Your health and insurance needs will evolve over time, and a good life insurance policy can accommodate those changes. For example, the best term life insurance policies can be converted to permanent life insurance.

Another good tip is to prepare for the life insurance medical exam . With a few tweaks of your daily routine and diet leading up to the exam, you can improve your chances for better results, which can help you land better rates.

Here are more of the top life insurance tips for 2021 .

What are the three types of life insurance?

The three main types of life insurance are term life, whole life and universal life insurance .

The most premium money goes toward whole life and fixed and indexed universal life insurance (35% and 34%, respectively. About 24% of premium money goes to term life, according to LIMRA.

How to Determine How Much Life Insurance Is Needed

Source: https://www.forbes.com/advisor/life-insurance/how-much-life-insurance-do-you-really-need/

Share this post