How much life insurance do I need? This is a difficult question to answer as it is different for everyone, of course. But thankfully, there are various formulas and rules of thumb that make it easier for you to get a sense of how much cover you need. So, if you want to form a good life insurance needs analysis, read on.
Why not try using a life insurance calculator?
When you take a look at an insurance provider’s website, you will likely find a life insurance calculator. Why not have a go at using one of these? After all, life insurance calculators provide an easy way for you to start thinking about what kind of coverage you will need, and for how long.
Your income times 10
If you want a quick low-tech way to get to grips with how much coverage you need, this well-known rule of thumb gives you a fast way to get a simple idea of what your family needs.
That being said, many people think that the income times 10 rule isn’t that suitable for the modern world. The rule fails to account for any savings and life insurance policies that you may already have and doesn’t take stay-at-home parents into consideration.
Your income times 10 plus $100,000 a child
If you have children, their education expenses will be an important component of your life insurance estimate. Indeed, your children are likely one of the main reasons you are looking at getting coverage in the first place.
In this case, the rule of your income times 10 is a good start at trying to calculate what you will need to pay your children’s tuition fees.
But just like with the previous rule, this formula still doesn’t fully take into account your existing life insurance coverage and assets, and your family’s true needs.
DIME
So if you would rather use a truly detailed rule of thumb, the DIME formula is the way to go. In this formula, the word DIME stands for Debt, Income, Mortgage and Education, which are four important areas to take a look at when you want to get to grips with your life insurance needs.
First, get a total of all your debts besides your mortgage, along with an estimate of what your funeral expenses will be.
Then, think about how many years your family would need support. Once you know this, multiply your annual income by the number.
After this, you need to figure out the amount you will need to pay your mortgage off.
And lastly, try to get a figure for the cost of your kids’ tuition fees for school and college.
When you add all these crucial figures together, you get a great picture of what you and your family’s true needs are. But while this rule of thumb is the most exhaustive yet, it still doesn’t begin to take into account your existing savings and life insurance coverage, and once again fails to acknowledge a stay at home parent’s unpaid contributions.
Try calculating a target coverage amount – obligations minus liquid assets
Rules of thumbs are a good way to begin to get to grips with understanding how much coverage you and your family need. But, as we previously detailed, these formulas don’t quite take into account your existing assets and other needs. Thankfully, though, there are some better ways to get an in-depth calculation of your coverage needs, which we are about to detail.
First of all, figure out what your obligations are. Get your average salary, multiplied by the number of years you think will need to replace your income. Then, add on your mortgage balance, the other debts you must pay, and your predicted future needs, like funeral costs or tuition fees.
This includes personal loans, tax debt owed to the IRS, credit card debt, home equity debt, capital gains tax, your mortgage balance, and any student loans or car loans you may have.
Also, if you are a stay at home parent, add in the cost of replacing the child care and other services you yourself provide.
From all this, take away your liquid assets, like your current life insurance, college savings that you already have, and existing savings.
What if I have young children?
If you are a parent to young children, a term life insurance policy can be ideal. However, longer terms like 20-year policies or even 30-year ones are best for families with very young children, so that the children get ample time to build up their own assets.
You’re also less likely to have to go without cover with a longer-term life insurance policy when the term expires and the rates increase.
What if I have a cottage?
If you have a cottage or vacation property, did you know that it is subject to capital gains tax? This is because a vacation property is seen as being an investment property, which means it has tax implications.
If you have a cottage, you will need to think about this and factor it into your calculations. Check out WEALTHinsurance.com to learn more about capital gains tax on cottages.
What if my family’s needs change?
If you think that you or your family’s needs are likely to change at some point, this is totally okay! In this case, why not think about purchasing multiple small life insurance policies as you need them, instead of just getting one big inappropriate policy.
This will ensure that you always have coverage that suits you, while also ultimately saving you money in the long run!
That being said, don’t under-protect yourself. It’s always best to buy a little more coverage than you think you will need, rather than not having enough when you need it. After all, your income will probably rise over time, although your expenses should rise accordingly too. But though it isn’t possible to truly anticipate precisely how steeply either will rise, some cushioning will help to ensure that your whole family can maintain their current lifestyle should something happen to you.
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