How Much Life Insurance Do You Need?

Here are some thoughts from the great personal finance book Grow Your Money!: 101 Easy Tips to Plan, Save, and Invest. They talk about how much life insurance you need as follows:

The rule of thumb is to buy about five to eight times your current wages. Another approach would be to secure enough coverage to meet major financial obligations, enough to pay off the mortgage(s), plus pay for the kids' college educations. On top of that, an additional sum could be provided to help the family transition from the loss of your income.

Here's where we stand on this issue:

1. We insure both me and my wife. I'll get to details on my life insurance in the next point, but on my wife we take out enough coverage so that our family would be able to function close to what it is now even without her. Since she's a stay-at-home mom, the costs would mostly center around childcare and household duties, but as you know, these expenses can add up quickly.

2. We insure me for about five times my annual salary, which is about 10 times our annual living expenses. In all reality, the amount we already have saved is probably enough for the family to survive without much impact to our lifestyle (we're frugal as a family, but my wife's the most frugal, so if I was gone, expenses would probably drop.) :-) But we keep a policy in place that provides an extra bit of cushion just in case a series of terrible events occurs and they need more funds. Besides, the policy isn't that expensive and it's in cash (not all of our net worth is that easy to access). And it will run out in the next decade or so since by then we'll be completely self-insured.

As for the method of determining how much life insurance you'll need, I like the following:

Total need - total liquid net worth + a bit of cushion = amount of life insurance needed

You want life insurance to fully cover your family's needs, but you don't need/want it to provide a huge windfall for them should you die. As such, look at what you'll need in total (let's say for five to ten years -- or some milestone like the kids graduating from college), subtract what you've already saved, then add in a bit of cushion (how much depends on how much risk you're willing to take), and you should be close to how much life insurance you need IMO.

Comments

[Financial Samurai]

Great formula, but how do you definie "Total Need" exatly?

It'll be interested to see how many people opt for supplementary life insurance over and above the employer coverage. Hmmm.

[Rich A.]

In response to Financial Samurai's comment, I've always believed that any employer coverage I might have is "supplementary" to the policy I purchase. I have never factored the employer coverage into our "total need". As we know now more than ever, jobs do come and go. I figure that if I die, and my wife gets insurance from my employer (I think it is one year's salary), then it is just an added bonus for her.

[MattJ]

Meh.

I'm single w/ no kids and my employer insures me at twice my base salary.

Given that my net worth is positive and that I purchased my home with more than 20% down, (I probably have about 25% equity right now) I really don't see a need for any insurance at all. There's a good chance that, by the time I do get married, I'll be able to self-insure.

Everyone's situation is different.

[Tim]

i agree somewhat with your take on life insurance. sometimes i think people consider life insurance as money to leave behind so your family doesn't have to work. life insurance should be sufficient enough to pay for expenses and expenses to train/educate the remaining spouse (if not working) until they have the capability to work and provide; otherwise, you are paying more than is necessary for life insurance. I know term life is cheap, but still, if you are looking at ways of cutting back, insurance is one of those things people pay more than necessary (not only life insurance, but property insurance etc).

[Strick]

This insurance "rule of thumb" has always been too generic to be of any value. I am a single provider for a SAHM and 3 young children. I did use a financial "rule of thumb", but a different one. I subtracted my current savings from 25 times my expenses + college costs and bought that much insurance. Now if I pass my wife can "retire" (raise 3 kids) on a 4% withdraw rate. Someone with little savings and in this situation who insured for 5-8 times their salary seems to have created a pretty tight and very temporary pool of money. Sure she'd prob go back to work before traditional retirement, but with term insurance so cheap for the young and healthy, why not make it as stressfree as possible?

[Denise]

If you are planning a life insurance policy, there are a number of factors to consider when deciding on the amount of coverage you need. These include funeral expenses, education loans, any pending mortgages or debts, and the financial support your family would need in your absence. Five to ten times your annual income is the normally recommended amount suggested. It is preferable to get a professional opinion about this before signing up for anything and many insurance providers and companies offer a personalized analysis of your financial needs, as part of their service.

Denise at AccuQuote
Disclaimer: I work for AccuQuote and this is my personal opinion.

[Trent]

I find it very difficult to say how much life insurance a person needs, because I have no idea what economic environment a person will be in over the next 2, 20, 50+ years. Taxes will change, interest rates will change, rules will change, as well as lifestyles. There will be more items introduced into our lives that we must have in the future than we have seen in the past.

I only know of one answer to the question how much life insurance I can get. That answer for me is whatever the most I qualify for from the insurance company. I cannot do better than that. I would be in a much better position whether I live a long life, a short life, or become disabled if I have all that I qualify for. I will not have to apologize to my family for the lack they might have for not leaving enough.

Life is not math, it is more like science. The premium on the life insurance is not the determining factor. A price will be paid either by paying a premium for insurance that will deliver and the opportunities that can be met because I have it, or a cost will be paid in loss of income, enjoyment, or goods and services that I, or my survivors will not have if I do not have the protection in place.