If you have people in your life who depend on you financially, or who stand to be hurt financially if you were to pass, then there’s no question about it: You need life insurance to ensure that your loved ones are covered if the worst were to happen. But just how much life insurance should you buy? There are several factors that need to go into that decision, like your annual salary, the amount of income replacement you’re looking for, and the amount you think you’ll need for final expenses, including funeral costs. Here, we’ll help you determine how large a life insurance policy to buy so you’re covered without going overboard.
There are many types of life insurance, and the kind of policy you choose will heavily influence how much your premiums (or life insurance fees) end up costing you. Life insurance is generally divided into two main categories: term life insurance and permanent life insurance.
As the name implies, term life insurance is designed to cover you for a certain period of time, whether it’s 10 years, 20 years, 30 years, or whatever term you choose. If you pass away during that window, the designated beneficiaries on your policy will get the death benefit the policy entitles them to. Therefore, when we talk about how much insurance to buy, we’re really talking about how much of a death benefit you’d like your loved ones to collect.
Term life insurance is considerably cheaper than permanent life insurance because it doesn’t cover you for life; rather, it runs out at a predetermined point in time. As such, when you buy term life insurance, you run the risk that it will expire before you need it. Furthermore, term life insurance doesn’t build a cash value over time, which means that once your policy runs out, it’s worth nothing to you, whereas permanent insurance does accumulate a cash value.
So let’s talk about permanent life insurance, because the primary benefit in getting it is lifetime coverage coupled with the opportunity to have your plan accrue a cash value account, which will grow at a guaranteed rate. The most common type of permanent life insurance is whole life insurance, which gives you the option to borrow against your cash value or even cash out a portion of your policy if you want or need the money (keeping in mind that the more you cash out, the less of a death benefit you get).
Variable life insurance is another permanent option, and it works just like whole life with one exception: Whereas the interest you earn on the cash value portion of a whole life policy is fixed, earnings on a variable life policy are — you guessed it — variable. The cash value account is invested in “sub-accounts,” which are similar to mutual funds, giving it the potential to grow much faster. On the flip side, it has the potential toĀ lose value.
Then there’s universal life insurance, which allows you to increase or decrease your death benefit as your needs evolve. Furthermore, you can use the cash value portion of your account to cover your premiums. Finally, there’s variable universal life insurance, which allows you to invest some or all of your cash value to grow it into a larger sum.
If you’re looking for a simpler life insurance product, your best bet is generally either a term life or whole life policy. And if you’re looking to keep your costs as low as possible, term is usually the way to go.
Though you can apply for life insurance by calling up different insurance companies and asking for quotes, a smarter bet is usually to find an independent insurance agent — someone who doesn’t work for a single company, but rather can get you quotes from a number of different companies. That agent will gather some basic health information about you to get those quotes, keeping in mind that the amount you’re charged for life insurance will depend heavily on factors such as your age and general health.
Once you decide to apply for a specific policy, you’ll be asked to complete an application that will ask detailed questions about your medical history. You’ll also need to complete a medical exam to get approved. Generally, your insurance company will send a nurse or medical representative to your home to make that exam more convenient for you. You can expect to have your weight and blood pressure recorded, and you’ll need your blood drawn to be tested for underlying conditions or diseases that might affect your eligibility for a policy. Once that information is processed and approved, your policy will be written up, at which point you’ll sign a contract, submit your first premium, and secure that coverage.
When it comes to buying life insurance, finding the best premium price and choosing between your various options is only part of the picture. You’ll also need to determine how much of a death benefit you want your beneficiaries to receive after you pass. Keep in mind that if you’re buying permanent insurance, your policy will accumulate a cash value, which means that you won’t necessarily need to wait until you die to collect that benefit; you can instead cash out your policy and take the money you’re entitled to.
That’s an important point to consider, because some people who buy permanent life insurance use it as a savings vehicle of sorts. If you’re hoping to accumulate cash in your life insurance policy that you can use in retirement, for example, then you’ll need to consider how much income you may want from that policy down the line (keeping in mind that there are other, and generally more cost-effective, ways to save for retirement, such as putting money into a 401(k) plan or IRA). For the purpose of this discussion, however, we’ll assume you’re looking to determine the right death benefit so that your beneficiaries are covered financially in the event of your passing.
The easiest way to figure out how much life insurance you should buy is to aim for a death benefit that’s a certain multiple of your income. Common choices include five, seven, and 10 times your salary, though many financial advisors suggest playing it safe and opting for the latter.
That said, there are other considerations that may prompt you to secure an even higher death benefit than a simple multiple of your salary. Here are a few to factor in.
If you pass away with outstanding debt, your loved ones may wind up responsible for paying it off. And that’s probably not a burden you want to put on them.
If you’re like most people, your single largest chunk of debt will probably come in the form of your mortgage, so it’s a common practice to factor that balance into your total death benefit. For example, if you owe $200,000 on your mortgage, you might add that sum to your total death benefit so your family can pay off your home loan when you pass. If you have other types of debt, such as that of the credit card variety, you should also account for it in your calculations. If you don’t, it will generally come out of your estate after your passing.
If you have children, then you might consider buying a life insurance policy that can cover some or all of their education costs. You don’t necessarily need it to cover the cost of the most expensiveĀ collegesĀ out there. Rather, aim to have your death benefit provide enough income to cover the cost of in-state college tuition, and perhaps room and board to boot.
Maybe you’ve always dreamed of paying for your children’s weddings, or giving them each a down payment to buy their first home. Those goals don’t have to fall by the wayside if you pass away sooner than expected. You can factor them into the death benefit you choose.
These days, the average traditional funeral costs between $7,000 and $10,000. That includes a funeral service, burial at a cemetery, and headstone installation. Many life insurance buyers include these and other final expenses in their life insurance policies so that their family members don’t have to think about bearing the cost on their own.
You might add up the aforementioned items, coupled with a certain multiple of your income, and land on a number that seems to offer comprehensive coverage for your beneficiaries upon your passing. But what if you’re looking for extra peace of mind? Perhaps you’d feel better knowing that your life insurance policy offers an extra financial cushion for your loved ones, whether it’s money to take vacations, pay for future medical expenses, or simply have more savings. If that’s the case, and you can afford a little extra coverage, it certainly doesn’t hurt to have it. That said, you don’t want to buy coverage you don’t need, either, as doing so could really add to your premium costs.
Once you figure out how much of a death benefit you may want for your loved ones, you can take a look at your existing assets and use that figure to offset the amount of coverage you need. For example, let’s say you earn $100,000 a year, and you want a death benefit that covers 10 times that amount. Let’s also assume you owe $200,000 on your mortgage, you’ll need $400,000 to cover college costs for your two children, you want another $100,000 to pay for two weddings, and you want an additional $50,000 to pay for your final expenses and give your family a modest cushion. All told, you’re looking at a death benefit worth $1.75 million.
But what if you currently have $100,000 in savings and another $150,000 in a college fund for your kids? You can then subtract that $250,000 and land on a $1.5 million death benefit, which will be cheaper to procure than a death benefit worth $1.75 million.
Another thing to keep in mind is that your employer may provide some amount of life insurance to you as part of your workplace benefits package. If that’s the case, you can deduct that amount from the total you’re targeting, provided that plan is portable — meaning it’s not tied to a single job and can continue offering you coverage if you switch employers. For example, if you’re targeting $1 million in coverage but have $100,000 in coverage through work, you can buy a $900,000 policy instead.
There’s another factor to consider, too: If you have a spouse who’s a stay-at-home parent, you may want to buy life insurance for him or her as well. The reason? Even though that person doesn’t earn an income, the fact that he or she is there to watch your children means you don’t have to spend money on child care. If you have young kids, then it pays to figure out the cost of child care and get a policy for your spouse with a death benefit that reflects that expense. On the other hand, if you have teenage kids who can get themselves to school and stay home on their own while you’re at work, then you don’t necessarily need to worry about child care costs.
Finally, if you’re struggling to figure out how much life insurance you need, you can always use this life insurance calculator to help you land on the right number. And if you’re still not sure, speak to your financial advisor, if you have one. He or she can make recommendations that help you buy the right amount of coverage for your family without going overboard.
Once you figure out how much life insurance you need, your goal should be to secure it at the lowest possible price. There are several ways you can save money on your life insurance premiums.
Term life insurance is pretty much always cheaper than permanent insurance when you’re talking about the same death benefit. If your estate isn’t particularly complex, and you don