How to Calculate How Much Life Insurance is Needed

March 19, 2019

Life insurance provides important protection for your loved ones – but how much is enough? According to LIMRA’s Trends in Life Insurance Ownership study, 60 million households have an average life insurance coverage gap of $200,000. New research from Atidot finds that only 26 percent of the current need for life insurance is being met.

People can become underinsured for several reasons:

  • They don’t calculate how much they actually need when purchasing a policy.
  • They don’t increase coverage even though their earnings and expenses have increased.
  • They forget that stay-at-home parents need life insurance, too. Even though they’re not earning a paycheck, they’re performing essential childcare and household duties, and paying for this help can be expensive. According to Care.com, a nanny cost an average of $580 a week in 2017, while an after-school sitter cost $242 and a child care center cost $211.

Whatever the cause, the result is the same. When families don’t have adequate life insurance coverage, an unexpected death can leave the surviving spouse and children struggling with debt and facing a lower living standard.  

Calculating Your Need

When calculating how much life insurance you need, you should consider three things:

  1. Your income. Consider the value of your salary, bonuses and benefits. For stay-at-home parents who don’t earn a paycheck, you can look at how much it would cost to pay for the services.

  2. How long the survivors will need income. A worker would expect to keep earning until reaching retirement age, and a surviving spouse may be depending on this income. Parents may focus on making sure they have enough coverage to last until their children are grown. 

  3. Your expenses.  This includes mortgages, student loans and other types of debt. Also consider other expected expenses, such as funeral costs and college tuition. Average funeral expenses can cost up to $10,000, according to Parting. A four-year college degree will cost $100,000 if the tuition is $25,000 per year.

To get an idea of how much life insurance you might need, take your annual income and multiply it by the number of years you want the payout to replace.

It sounds simple, but it involves a difficult decision – exactly how many years do you want to replace? Some advisors have used the 10-year rule. Let’s say you make $50,000 a year. According to the 10-year rule, you multiply that by 10, and get $500,000. This is the minimum amount of coverage you need.

It might not be enough, however. Imagine a 30-year-old man with a wife, a two-year-old child, and 20 years left on his mortgage. If he gets $500,000 in coverage, and his family goes through the money in 10 years, what is his family going to do after that? His child will be 12, and there will still be 10 years left on the mortgage. In this case, he might want enough coverage to last for 20 years, until the mortgage is paid off and the child is grown. This means he’s looking at $1 million in coverage.

This sounds like a lot, but that’s only because you’re looking at it as one lump sum. When you think about a person’s lifetime earning potential, it doesn’t seem like that much. In fact, some people will need even more, depending on their income and expenses.

Whatever figure you decide on, make sure it’s enough to cover your family’s expected expenses and debts, and get both spouses insured regardless of whether they work. Life insurance is more affordable than most people expect. For more information and options, contact our Life Insurance team.