How much insurance do I need? You might have asked yourself this question at some point. Not everyone needs life insurance. If you don’t have assets to protect and you don’t have children who depend on you, then better spend your money elsewhere rather than getting yourself coverage. Of course, there are other variables, as well, so you need to talk to your financial counselor to get sound advice regarding your unique circumstances.
Assuming that you are looking to be protected, the next step would be to determine what type of insurance is right for you.
For that, we need to touch on the different types of life insurance so you will have a better idea of what type of coverage you have to apply for.
Basically, life insurance has two main subsets: term life insurance and permanent life insurance. The main difference between them is the former has an expiration date.
Term vs Permanent
Term life insurance can be as short as one year up to a maximum of 30 years (some carriers even longer). The benefits will only take effect upon the death of the premium holder. The value of the insurance will go to the beneficiaries identified in the contract. There are several ways to pay for the insurance amount, depending on the policy of the company—monthly, quarterly, semi-annually, or even annually.
In terms of costs, term life is much more affordable compared to the whole or permanent life insurance.
Permanent life insurance, meanwhile, has no expiration date. As long as you are religiously paying your premiums you can expect that you are covered by insurance for the duration of your life.
You may ask why permanent life insurance costs more?
It’s because of the unique cash value component of the contract. When you pay your premium, a portion of that money will be used by the insurer to invest.
“How much life insurance do I need?”
Finally, we get to the crucial part.
It’s really quite easy to answer the question, “how much life insurance do I need,” as long as you know where to begin.
Ask yourself the following questions:
How much is left in my mortgage?
What other debts to I have outside of my mortgage?
Am I spending beyond my means?
Are my debts accruing every month?
How much am I spending every month?
How old would I be before the children finish school?
How much is my employer paying for my insurance?
Knowing how much you are spending every month will help you calculate your annual expenses. This will help you answer the question of how much life insurance do you need. If you are spending $2,000 a month, that equates to $240,000 annually.
A $500,000 insurance policy will only last your beneficiaries two years if they don’t have any expenses.
This is why you also need to institute force savings out of your salary and earnings. Financial advisers are suggesting to adopt the “50-30-20” method. For instance, if your salary is $4,000, half of that should be spent toward basic necessities. About 30% should go for emergencies and contingencies, while 20% is forced savings.
10 times 10 Rule and DIME
Perhaps you’ve heard about multiplying your earnings by 10, which would be the amount of your life insurance you would purchase. But many people think that this rule is outdated considering the many variables that affect expenses.
Instead, the insurance cost should be 10 times more than your earnings in addition to the $100,000 for each child to cover their education.
When answering the question, “how much life insurance do I need?,” considering the word “DIME,” which is an acronym for Debt, Income, Mortgage, and Education.
Debt – Your debts and obligations won’t go with you after you die. Your estate will have to settle your obligations and whatever is left will be divided among your heirs. This is why you have to calculate all your payables along with the funeral expenses.
Income – How old are your children now? Do you have a chronic illness that may impact your capacity to work or earn for the family? How long do you think you can support your children before they flew the coop? You can then calculate your yearly income by the number of years your children will be dependent.
Mortgage – This is should be easy to calculate, and this makes sure you leave your children a home when you pass away.
Education – Life insurance is a good fallback to guarantee that they will not be forced to stop schooling.
Make a Financial Plan
Now, we are back to our earlier question.
How much life insurance do I need?
There’s no way to answer that question without first making a financial plan.
The financial plan will include every aspect of your earnings, expenses, taxes, debts, and retirement.
For instance, look at your Social security benefit to find out how much your pension would be after you retire. Is the money enough to supplant your future expenses?
You should also calculate your total savings (20% of your income) by the time you retire.
Typically, you only need life insurance up until you retire or when your kids are no longer depending on you, whichever comes first. By the time you are of retirement age, your passive income will have kicked in to support your daily expenses. The savings can be used for your funeral expenses.