Buying Life Insurance: How Much Do You Need?
It’s an unfortunate fact that death and taxes are the only two guarantees in life. We’d like to add buying life insurance to that list.
We understand that life insurance is kind of a morbid industry. The whole point of life insurance is for an insurance company to pay a specified amount to your family after you pass away. These policies are designed to take care of your family when you are no longer around to do so.
Nobody wants to think about their mortality but, unfortunately, a life insurance policy is the cornerstone of a good financial plan.
If you are well-prepared, you have already started thinking about the legacy you will leave behind for your dependents. Do you know how much life insurance you need to purchase?
Buying life insurance is tricky for many reasons. You have to consider your current financial status and any future bills that may take place. While it may sound like a fancy guessing game, there are actually a few rules to follow when deciding how much life insurance you need to purchase.
Life Insurance Recap and Review
Life insurance comes in two categories – whole and term.
Whole life insurance stays with you for your whole life. In exchange for premiums, you are given a policy that builds cash value. With some policies, the premiums you pay are invested back into the market.
Term life insurance is cheaper than whole life insurance and protects your for a certain term – anywhere between 10 and 35 years.
While there is a life insurance policy for everyone, life insurance is not for everyone. If you are debt-free, have no dependents, and have saved enough money to cover death and funeral expenses, then you may not need a life insurance policy.
Typically, this applies to younger individuals. Most life insurers will try to scare you into thinking the earlier you apply for life insurance, the better off you are. This is due, in large part, to the fact that insurance companies make their money off of how long their clients will live. The younger you are, the lower your risk and the greater the likelihood that you will outlive your policy.
In reality, you can find an affordable life insurance policy at any age! Finding an affordable policy is a matter of assessing your needs frequently and reaching out to a reputable agent.
Assessing Your Life Insurance Needs
The face value of your life insurance policy depends on many factors. Let’s take a look at some of the things you will need to consider before purchasing your life insurance policy.
Are you the sole provider of your family? Can your family get by without your income?
The idea behind a policy is to make sure that your family is not financially burdened by your passing. Dealing with the death of a loved one is stressful on its own, without added financial strain.
You should be calculating enough money to replace your income until your family gets back on their feet. Obviously, a life insurance policy is not guaranteed to last forever; however, you may want to consider buying a policy that replaces at least 10 years of your income. Then, add your income back into that face value to protect against inflation.
For example: if you make $50,000 annually, your policy’s face value should be $500,000. Adding your income back into this to safeguard against inflation would bring your policy’s face value to $550,000.
Who Are You Insuring?
Another factor to consider is who you are insuring with this policy. If you are insuring just yourself, you can skip this step. We recommend considering life insurance for any member of your family whose death would result in a financial loss for you.
In most cases, this means covering a spouse or partner. This is especially important if you share mortgage responsibilities or co-own a property. Occasionally this means covering a business partner; however, we will cover this in more depth in later posts.
Life insurance policies for your spouse or partner function in much the same way as your own life insurance policy. Consider purchasing a policy worth at least 10x their income, then add padding for inflation.
If you are purchasing a policy just to cover debts – and you have no dependents – you have life insurance alternatives. Credit card companies and banks offer products called insurance deductibles for your outstanding debts. These are only a few dollars a month, and guarantee that your debt will be paid in full once you pass.
Debt is an important consideration for life insurance policy size.
Will all of your debts be paid if you passed away tomorrow? In the next year? How about in five years? Sitting down with your agent and financial planner and reviewing all debts in your name can help you get a policy size that covers everything adequately.
Debts can include:
- Credit Cards
- Car loans
- Student loans
- Medical bills
Once you have figured out the lump sum of your debts, you will want to calculate interest. As a reminder: you may have your policy for a long time, and you want to make sure your benefit is large enough to cover any interest accrued over the years.
The Purpose of Your Policy
More is not the goal with your life insurance policy. The goal is coverage you can afford now, that will protect your family in the future. If your policy is just to cover your final expenses, you will want a smaller benefit. If your goal is to use your life insurance as an investment strategy, you may want to start with a medium-sized policy, as it will accumulate a cash value over time.
Remember: life insurance is not an investment tool. Even if you are using your policy as an investment supplement, you should be sure to have alternative means of investing and saving for the future!
Other Policy Considerations
A quick Google search can tell you that most insurance companies recommend your death benefit be worth six to 10x the amount of your annual salary. You can also calculate your policy by multiplying your annual salary by the amount of time you have left until you reach retirement.
For example: if you are 50 years old and make $40,000/annually, you can purchase an insurance policy for $600,000 ($40,000×15 years until retirement age). This should be enough to cover your expenses and supplement your income if you pass away.
Standard of living is also a consideration for calculating policy size. You want to ensure that your beneficiaries can maintain their standard of living after you pass away. Retired and older individuals often face a downsizing in their standard of living, so if you are nearing retirement and have downsized, your policy should shrink accordingly. This will ensure that you are maintaining affordable premiums and that your policy size fits your dependent’s lifestyle needs.
Preparation is Key
If you are going to buy a life insurance policy, you want to make sure the benefit is big enough to cover your needs.
We know the process of detailing all your current and possible future debts is a daunting one. An independent agent can help. You should sit down with your agent and discuss your policy goals, current financial situation, and potential debts. Your agent can marry all of these aspects and ensure that you are finding the best policy possible.