Everyone knows they should be getting life insurance.
But more than anything else, the biggest question is how much life insurance do I need? Unfortunately, there’s no quick or easy answer to that question, at least not if you want a reliable number – because everyone has different needs.
But to help you determine how much life insurance is enough – and how much might be too much – the information below should help you get reasonably close to the best coverage amount for you.
How Much Life Insurance Do I Need – Rules of Thumb
There are rules of thumb to help you determine how much life insurance you need. But they’re mostly created by the insurance industry, and frequently repeated by those on the outside.
The most common rule is to simply multiply your annual income by ten. Part of the popularity of this “rule” is that it’s incredibly simple. Even if you know nothing about life insurance, you can use this as a default estimate. And you can rest assured insurance agents love it because it can so easily result in very large life insurance policies.
The basic idea is that if you earn $100,000 per year, you’ll be adequately covered if you take a policy for $1 million.
That rule of thumb is actually not without merit. But I would suggest using it only as a starting point, being prepared to make adjustments where needed.
How Do You Determine How Much Life Insurance You May Need?
A more accurate way to determine how much life insurance you may need is to crunch the numbers. Rather than relying on a rule of thumb, which is really just an educated guess – and maybe a wild one at that – you can go through the steps that will provide you with a reliable policy amount.
You can do that by calculating the numbers you’ll need to add to your policy, as well as account for those you’ll need to subtract.
Let’s go through the steps…
What to Add to Your Life Insurance Policy
Rather than starting with an arbitrary fixed number, we’re going to look at your real expenses and other obligations in determining a gross life insurance policy amount.
Your Household Living Expenses
This step can get a bit complicated because you’ll need to get a fairly accurate number. The best way to do this is to tally all your expenses for the past year. That may involve analyzing your checking account, credit cards, and any other accounts you run living expenses through. (My advice: good budgeting software can make this easy and a lot less time-consuming.)
Let’s say you determine that your average monthly expenses are $4,000. That’s $48,000 per year.
Next, determine the number of years you’ll need to provide that amount for your loved ones following your death.
For example, if you’re 30 years old and you expect your children to be fully emancipated in 20 years, you can use that number. By multiplying $48,000 per year times 20 years, you’ll get $960,000.
Now the situation becomes a bit more complicated if you have a non-working spouse, who you’ll need to provide living expenses for throughout his or her life. But to simplify the equation, you can just calculate that number through age 65, when Social Security and other retirement benefits will become available.
This is where you’ll have to do some serious math because the likelihood is your spouse’s living expenses will drop considerably once your children are emancipated.
But for simplicity's sake, let’s just assume your spouse will be self-supporting, and use $960,000 for this category.
You’ll naturally want to provide a cushion for your family after your death. That can include an annual allowance for emergency expenses, as well as irregular expenses (major car repairs, medical expenses, etc.). If that’s $4,000 per year over the next 20 years, it’s an additional $80,000.
In addition, if your spouse is not employed, you may want to make an annual provision for his or her retirement savings, like an IRA. If your spouse is also 30, you may want to allocate an additional $6,000 per year for an annual IRA contribution. To cover 35 years, that will require an additional $210,000.
College – if you have any children
This is a tough one to plan for because college costs have seriously escalated in recent years. There may be no adequate way to adjust for those price increases. But you may want to set a certain dollar amount, such as the cost of a four-year undergraduate degree at an in-state college for each child.
If you have two children, and the cost of that education will be $100,000 each, you’ll need to add $200,000 to your policy.
Pay off of Debt Obligations
One of the best ways to provide for your family after your death is by paying off debts. This is especially true of large loans, like the mortgage on the family home or any student loan debt you or your spouse have. (Even if your student loans may be canceled upon your death, as is the case with federal student loans, you may still want to make an allowance for this in case the rules change.)
If your house currently has a $200,000 mortgage, and you have $50,000 in student loan debt, you should add another $250,000 to your policy.
Extra Childcare Expenses
Whenever one parent dies there’s real potential to create a childcare expense that didn’t exist before. You’ll want to accommodate this need if it’s a possibility.
Generally speaking, you should consider providing childcare if you have children under 12.
If the cost of that care is $10,000 per year per child, and you have two children – ages seven and five – you’ll need to provide for a total of 12 years. That can be broken down as seven years of childcare for the five-year-old, and five years for the seven-year-old.
That being the case, you’ll need to provide an additional $120,000.
Naturally, this won’t be required if your children are over 12, or if you don’t work and will be home to provide care.
The Cost of Your Final Expenses
There’s a long list of potential expenses relating just to burial or cremation. A relatively modest funeral could easily top $10,000, so you may want to provide at least an additional $20,000 in your policy.
But there may be other expenses as well. For example, there may be out-of-pocket medical expenses or even costs for end-of-life care. The best you can do is an estimate. That could be something like $50,000 in total final expenses.
What to Deduct from Your Life Insurance Policy
So far, we’ve just been adding provisions to your policy amount, which can admittedly seem overwhelming. But you’ll be glad to know there are a few items you can deduct from the total, and some are substantial.
Your Spouse’s Income – If it Will Continue
If your spouse is employed and can comfortably afford to cover at least half your family’s living expenses, you can reduce your anticipated life insurance amount by $480,000. That’s half of the $960,000 we calculated above.
Obligations that Will Disappear upon Your Death
There are undoubtedly expenses you have that will no longer exist upon your death. Those can include your 401(k) contributions, a car for commuting, and any debt payments that will be eliminated when any loans are paid off upon your death.
If the total of those obligations comes to $1,000 per month or $12,000 per year, you’ll be able to eliminate $240,000 from anticipated family living expenses covering 20 years.
Financial Assets you Currently Have
Let’s say you currently have $200,000 in financial assets. That includes bank accounts, investment accounts, and retirement accounts. You can deduct that amount from your death benefit since it’s already a part of your estate.
Your Employer-Sponsored Life Insurance Policy – Maybe!
On the surface, you should be able to deduct the face amount of any life insurance you have through your employer. But I would advise you to tread lightly here.
Employer-sponsored coverage can disappear if you lose your job. That’s a distinct possibility if your cause of death is preceded by a prolonged period of disability, or especially if the illness or injury ultimately caused your unemployment.
My recommendation is that you consider an employer-sponsored plan as bonus life insurance coverage only. If it’s still in place at the time of your death, your family will have extra funds. But if it isn’t, at least you won’t have included it in calculating your family’s needs.
Putting it All Together – How Much Life Insurance Do I Need?
Let’s put it all together and calculate approximately how much life insurance you may need. We’ll assume your spouse is employed, contributes half the household living expenses, and funds his or her own retirement plan.
Starting with the additions:
- Your household living expenses: $960,000
- Future savings: $80,000
- College (for two children): $200,000
- Payoff debt obligations: $250,000
- Extra childcare expenses: $120,000
- The cost of your final expenses: $50,000
That’s a bit of a scary number, don’t you think? But not to worry, it’ll be reduced by the following deductions:
- Your spouse’s income: $480,000
- Obligations that will disappear upon your death: $240,000
- Financial assets you currently have: $200,000
- Your employer-sponsored life insurance policy: not considered
TOTAL – $920,000
When you subtract $920,000 from $1,660,000, that leaves you with a reasonable life insurance need of $740,000 – let’s call it $750,000 to keep the numbers round.
That will provide you with a fairly accurate death benefit. But you should also do a similar calculation for your spouse, to determine the size of his or her policy. The adjustments may be different based on variables in his or her specific circumstances.
Now if you used the 10x Income rule of thumb you might go with a $1 million policy and call it a day. But as you can see from our calculations above, you actually need 25% less life insurance.
How much money will that save you over 20 or more years of paying life insurance premiums?
Where to Get Low-Cost Life Insurance
After crunching the numbers, it may quickly become apparent that you need more life insurance than you ever believed. But don’t be intimidated! There are life insurance companies specializing in low-cost policies you can get in as little as a few minutes.
Ladder offers term life insurance to those between the ages of 20 and 60 – they work with salaried agents who aren't paid by commission. With Ladder, you can get as much or as little coverage you need, adding to plans as necessary to “ladder” them up. They are available in all 50 states with terms that range from 10 to 30 years.
Fabric is another all-online life insurance provider. But if you prefer live assistance, they have a team of insurance agents available to help. You can get up to $5 million in life insurance with terms of 10-, 15- or 20-years.
Fabric policies do typically require medical underwriting, but there is generally no medical exam required on policies of not more than $1 million. The company also offers accidental death insurance.
Here's my full list of recommended life insurance providers if you want more options.
Final Thoughts on How Much Life Insurance Do I Need
It may seem a bit complicated to calculate a reliable number for a life insurance policy, but it’s probably a lot less difficult than say, filing your income tax return. And it’ll certainly be worth the extra time and effort when you consider what hangs in the balance – your family’s survival in your absence.
Crunch the numbers and try to come up with the best insurance estimate you can. It’ll be better if you have a little bit too much insurance than not enough. But you won’t know that unless you do a deep dive into exactly how much will be needed.
Your family will appreciate your effort if the day ever comes when your life insurance policy needs to be paid out. And if it never does, you’ll rest a lot easier knowing that you’ve got everything covered even after you’re no longer around.