How to Decide How Much Life Insurance You Need
When deciding the amount of coverage right for you, the best course of action is to examine your annual income, financial needs, and obligations.
Consider a level term insurance policy to provide a death benefit comparable to your annual salary, a decreasing term policy to ensure car loans or student loans are paid off, and an increasing term policy to cover increasing expenses as your life changes.
Assessing Your Life Insurance Needs
There are many reasons to purchase a personal life insurance policy, such as providing an inheritance for your children or paying off any unpaid debts and final expenses. When assessing your life insurance needs, insurers and their insurance agents use methods to help you decide how much life insurance to buy. These methods include the human life value approach and the needs approach.
The human life value approach calculates your future earnings and subtracts taxes and necessary living expenses to give you a lump-sum death benefit amount. This method of determining your life insurance needs is not as detail-oriented as the needs approach. The human life approach is more of a generalized method of determining your life insurance needs.
The needs approach reviews each individual’s specific needs in determining the amount of life insurance to buy. It examines your current income, your family’s income, your personal assets and liabilities, expenses, financial needs and goals, and your risk profile (chance of loss). This type of approach addresses two basic insurance needs, a lumpsum death benefit and providing survivors with a standard of living.
Lump-sum death benefits can cover a variety of expenses, like medical and funeral costs, debt, and estate taxes. It can also be used to ensure dependents have an emergency fund, can pay off a mortgage balance, or can pay for their education. Another factor in assessing your life insurance needs is your dependents’ ongoing income needs.
A lump-sum amount will pay out immediately upon your passing away, but your family may need a stream of income to preserve their standard of living. Social Security benefits provide some income for a limited amount of time but probably won’t cover your family’s standard of living. A family income life insurance policy is a term insurance policy that pays a monthly income to beneficiaries.
Deciding Your Term Length
When buying life insurance, the length of time you pay premiums should be a factor. With a permanent insurance policy, you may pay premiums your entire life; with a term insurance policy, you pay premiums for the length of the policy’s term. This could be until you reach a certain age or for a specified amount of years.
When deciding your term length, examine your financial concerns. If you want to ensure funeral expenses are met upon your passing, a 20-year term insurance policy is a good option. The policy stays in force as long as you maintain the premiums and can be renewed if you outlive the policy term.
A decreasing term insurance policy is the best option to pay off unpaid debt and cover financial needs, such as mortgage payments, car loans, or your child’s education. The term length is the length of the mortgage or other loans, and the premium and balance decrease as you make payments toward the loan until it is a zero balance.
You should also take into consideration your minor children and how they would be taken care of in the event of your passing. A term life insurance policy for the amount of time it takes your children to mature will cover child care if you pass away before they reach adulthood.
Calculate Your Life Insurance Coverage Amount
Your life insurance death benefit is called the face amount of the insurance policy and is also the coverage amount. These three terms are interchangeable and indistinguishable. If you have a $50,000 life insurance policy, the death benefit, coverage amount, and face value of the policy are $50,000.
An established method consumers use to pinpoint how much life insurance to buy is DIME, an acronym for debt, income, mortgage, and education. When calculating your life insurance using the DIME formula, count all the debt you would have if you died tomorrow, plus future costs like your final expenses.
Next, multiply your annual salary by the number of years you believe your income should provide for your family (until they can provide for themselves). For instance, if you are the breadwinner, your spouse is a stay-at- home parent, and your child is 10 years old, a reasonable number of years to provide for your spouse and child is eight. Your child will be an adult, and your spouse may be able to provide more effectively by then.
After this, factor in your remaining mortgage and your child’s education fund (if applicable). This will be your DIME recommended coverage. For example, you are $30,000 in debt, have an annual income of $75,000 that you want to last eight years, have a $50,000mortgage, and want $100,000for your child’s education. Here’s the DIME formula in action: $30,000 + $600,000 ($75,000 x 8 years) + $50,000 + $100,000 = $780,000.
