It’s a reminder that, after all, we’re mortal and one day we won’t be around anymore. In fact the subject bothers some people so much that they don’t even look into getting life insurance.
But you won’t do that, will you?
To help make getting life insurance easier for you I’m going to tackle a couple of common questions when considering life insurance — why do i need life insurance and how much should I buy?
When Most People Start Thinking About Life Insurance
Life insurance isn’t needed for everyone at every stage of your life. But there tends to be a few times when people get particularly interested in getting life insurance.
According to a recent State Farm survey (go take a look over at GoodNeighbors.com), 4 out of 10 people will buy life because of a life event such as getting married, buying a house, or having a baby.
Having children is what got my wife and I thinking about life insurance. We each wanted to make sure the other would be taken care of should something happen to one of us (or the kids would be cared for should we both leave pre-maturely).
Let’s get back to how much life insurance you’ll need.
The two biggest aspects we’ll consider here are why you need life insurance and how much you need to cover with it.
Before we look at how much life insurance you should get let’s first look at why you want the life insurance in the first place. This will help us in figuring out how much you need.
Why You Want Life Insurance
Income Replacement for Those That Depend on You
This is one of the most common reasons to get life insurance. You want it so that people who would normally depend on your income will be able to take care of themselves after you’re gone. Usually this is your spouse and children.
What you’re basically doing here is getting life insurance as income replacement since you were the wage earner. Take into consideration any income your spouse has as well. You may only need to cover part of your income if your spouse has significant income.
If you’re replacing income to provide for your children you’ll only need it until your youngest turns 18 or until she finishes college. The assumption is they can start their own careers and pay for themselves after that time.
To Payoff Debts and Expenses
At first this sounds like a strange reason. Why would you need money to payoff debts after you’re gone?
This goes back to leaving money for those that depended on you.
Similar to income replacement, this reason looks at leaving enough money to cover any outstanding debts you may have, the biggest one here probably being a mortgage.
You can also use your life insurance to cover your “final expenses.” By that I means expenses like funeral costs, hospital expenses, or estate taxes.
As an Inheritance
Some people want life insurance as a means to leave an inheritance to those they are leaving behind. The money isn’t to specifically pay for anything. It’s to make sure your heirs have a little something and are comfortable. Even if your spouse works you may want them to be able to not worry about going back to work.
Child and House Care of a Stay-at-Home Spouse
The stay-at-home spouse provides incredible value to the household. If you have children you might want to consider what it would cost to care for the kids if the stay-at-home spouse we no longer there to care for the household. You might need to cover things like daycare in order to get by.
One way people use life insurance is as a means to help their children pay for college. You can be confident college costs are taken care of even if you won’t be around to see them graduate.
A Mix of These Reasons
No one if these reasons are necessarily the right one for you.
First, you may have other reasons for life insurance I didn’t mention here. That’s fine. This is a guideline of some of the more popular reasons.
Second, it’s OK if you combine different reasons in figuring out how much life insurance you need. The point in this first exercise is to see why you want the life insurance. Once you have your reasons you can better determine how much you’ll need.
How Much Life Insurance You Need
Once you know why you want life insurance it gets easier to estimate how much life insurance you need.
There are some general rules of thumb, such as getting seven times or 10 times your yearly salary in coverage, but, really, how much life insurance you need comes down to your personal financial situation, and what you hope your life insurance will accomplish.
Another tool is to look at your income, debts, and any other monetary amounts your heirs may need after you’re gone and then figure out how much total capital you would need in an income-producing portfolio to produce that amount every year, taking out 4% for your yearly needs.
If you earn $50,000 a year, your family would need $1.25 million in capital. According to different economic theories, this method would ensure that money lasts indefinitely. You might want to add that number to estimated funeral expenses and your debt repayment amount so that your family has the needed capital after everything is taken care of.
Another way to figure out what your family needs is to add up yearly expenses or income, and figure out how long they would need to be provided until your youngest child is of age (if you were looking to provide income for your children if you were gone).
If you make $50,000 a year — and assume that you spend that much — and your youngest is five years old, you would need to figure $50,000 a year for 13 years (until the youngest turns 18). In our example, that would be $650,000. You can then add other expenses that you have, such as debt pay off, funeral expenses and other things you would like to pay for (such as college costs) to the base income replacement number.
When you are looking at how much life insurance you need make sure to take retirement account contributions (this could lower the amount you’d need), the cost of benefits (like health insurance), and the cost of services that might need to be hired (like child care or housekeeping) into consideration.
Again, this all depends on your reasons for the money. You wouldn’t need the same amount to cover college costs as you would as income replacement or debt repayment or if you just want to cover funeral costs.
What About Life Insurance I Get From Work?
A lot of employers offer up life insurance. Many times though this life insurance renews year-to-year and depends on you still working there (the plan may not be portable or be expensive if it is). Think of insurance from employers like this as icing on the cake and not as a big part of your calculations.
Final Word On How Much Life Insurance You Should Buy
You may not want to think about not being around anymore but making a plan now can ensure your loved-ones are taken care of. It’s a pretty good feeling to know your family won’t have to worry about money as they mourn.
We didn’t go into the different types of insurance that are out there such as term vs. whole life insurance or other products like universal and hybrids but the typw you buy may have an impact on your calculations.
When you ask yourself ‘how much life insurance should I buy?’ take a look at the reasons you want life insurance and you have a good starting point in estimating your needs.