How Much Life Insurance Should You Have?

The generic rule when trying to figure out how much life insurance you need is to multiply your pre-tax income by 10 to 15. So, if you make $100,000 per year in pre-tax income, you will need $1 million to $1.5 million in coverage.

The idea behind this rule is to leave your beneficiary(s) enough money so that they will have time to recover from your loss. This can be a good starting point when figuring out your life insurance needs, but a more accurate gauge would be to conduct a LIFE needs analysis.

A LIFE needs analysis is an acronym that helps you get a more accurate gauge of how much life insurance you truly need beyond the generic 10 to 15 times your income rule. Each letter of a LIFE needs analysis stands for a different area of your life that you might want coverage for should you pass away. You write down the amount of coverage you need for each letter and then add up the total of all letter for a final number.

a) Liabilities - You want to list out all of the items that you owe money on that you would want to be covered in the even that you die unexpectedly. This can include a mortgage, car loans, credit cards, and personal loans.

For example, say that you had a mortgage that you still owed $500,000 and two car loans that you owed $50,000 on combined. You would combine these two for a total of $550,000 to get the total needed for the liability section.

b) Income - You want to estimate how many years your family would be dependent upon your income if you were to pass away and add that to your coverage. For example, say that you have a spouse who does not currently work to take care of your young children.

You would want enough income coverage to take care of your children until they grow up. If you estimate that it would take 15 years for your children to be independent and you make $100,000 per year, you would need $1.5 million in coverage for this section.

c) Final expenses - If you pass away unexpectedly, your family will have to cover the final expense associated with that including your funeral and burial costs. You want to estimate what this would cost and add this to your coverage. For example, you might estimate that your funeral and burial expenses would cost $15,000.  

d) Education - If you have a few children and plan to pay for their education, whether that be college or trade school, you want to estimate these costs and add them into your coverage. If you assume that each of your children's education is going to cost $100,000, you would need an additional $100,000 to your policy per child. If you have two children, you would need another $200,000 added onto your policy.

e) Add the total - Once you have done an in depth analysis for each letter, you need to add up the total. Using the numbers listed above, you will need $2,265,000 worth of coverage. If you were to simply multiply your $100,000 income by fifteen, you will be underinsured by $765,000. Going through a LIFE needs analysis gives you a more accurate amount of the coverage you truly need.

If you have a life insurance policy through work, you might be wondering if you should factor that in when determining how much life insurance you need. The short answer is no. The life insurance benefit you get from work is called group life insurance.

There are a couple of problems that come from trying to fulfill your life insurance needs with group life insurance. First, the coverage amount is typically not enough for your needs. Most employers will offer a base coverage of $50,000 or 5 times your annual salary. Some employers may allow you to purchase more coverage for an increased cost.

If your employer offers this base coverage for free, it is fine to opt in to it to have additional coverage. However, it is not a good idea to rely heavily on your life insurance benefit at work for substantial coverage. Instead, most of your life insurance should come from outside of work.

This leads to the second problem with group life insurance. Your life insurance benefit is dependent upon your employment. If you were to leave your job, or get fired, you would lose your life insurance benefit. Additionally, your employer can change the terms of your policy meaning the policy is out of your control.

Let's look at an example to further explain the points above. Say that you went through a LIFE needs analysis and determined that you needed $2 million worth of life insurance coverage. However, let's say that your employer offered life insurance coverage 5 times your salary and your employer covered the cost.

If you made $100,000, you could get $500,000 of life insurance through your work for free and buy the remaining $1.5 million you need in coverage through a private policy. Let's say you do this, but then need to leave your job 5 years down the line.

Let's assume that you find a new job, but your new employer does not offer a life insurance benefit. When you leave your old job, you will lose half a million in coverage. You would need to add another half million in coverage to your policy outside of work to be properly insured.

Since you are 5 years older, it is going to be more expensive to do so. The point here is that it is better to own all the life insurance you need outside of work so that you can control the coverage. Think of life insurance through work as bonus coverage, but don't make it your primary life insurance coverage.

The short answer is yes. The most common scenario in which this question arises is with a married couple in which one spouse works and the other spouse stays at home to take care of their children. The spouse that works obviously needs life insurance as they are supporting the family financially.

However, the spouse that does not work also needs a life insurance policy. Although this spouse does not have a job in which they earn income, they do have a job in taking care of their children. This is a full time, unpaid position.

If the spouse who does not work passes away, the spouse who does work would have to cover the costs needed to help them take care of their children. This might include after school care, and a full time nanny. This is why it makes sense for the non-working spouse to also have a life insurance policy.

If the non-working spouse passed away, but had a life insurance policy, the death benefit can be used by the working spouse to help cover the costs of childcare. If you find yourself in this scenario, you want to make sure that yourself or your spouse has life insurance coverage even if they do not work.

The amount of coverage that a non-working spouse needs is the amount of money it would cost to replace their work per year times the number of years until the children are dependent. For example, let's say that the cost to replace the unpaid labor of the stay at home spouse was $30,000 per year.

If you assume that you would need help replacing the labor of the non-working spouse for 10 years, the non-working spouse would need $300,000 worth of life insurance coverage.  

The best time to buy life insurance is right now. The reason being is that life insurance is cheaper when you are younger. The longer you wait to get coverage, the more you will pay. After you complete a LIFE needs analysis, you should try to get a policy into place as soon as possible.

This will allow you to buy all the coverage you need at an affordable cost. If you wait to get insured, you might end up only being able to afford part of the coverage you need. This will leave yourself, and more importantly your loved ones vulnerable.

1) Age - The younger you are, the cheaper your premiums tend to be as you are less likely to die. A healthy 20 year old has much longer to live than a healthy 60 year old. If you want a life insurance policy, it is best to buy one when you are young to lock in an affordable premium.

2) Gender - Life insurance is cheaper for women than it is for men. On average women will live longer than men which means they will typically outlive their life insurance coverage if it is a term policy.

3) Health - Your health plays a huge factor in the price of your life insurance as better health will get you into a better risk class rating. Life insurance companies will look at your height and weight, and any pre-existing medical conditions that you have or previously had. The healthier you are, the less you pay.

4) Family medical history - In addition to your own health, life insurance companies will also look at the medical history of your family. If you have had family members that have died from cancer or heart disease, you could end up paying a higher premium.

5) Smoking/tobacco use - If you smoke, chew tobacco, use a pipe, vape, or use e-cigarettes, you will pay a higher premium for coverage. Life expectancy is 10 years shorter for smokers than it is for non-smokers. Life insurance companies charge more to take on the risk of insuring you.

6) Type of policy/coverage amount - Term life insurance is cheaper than permanent life insurance as it only offers a death benefit and does not build any cash value. Additionally, the more coverage you have, the higher your premiums will be. $1 million of coverage will obviously cost more than $500,000 of coverage.

7) Hobbies - Participating in dangerous hobbies can cause the price of your premiums to increase. Any activity than a life insurance company believes will increase your chance of death is more of a risk to them and you will be charged more for coverage. This might include scuba diving, drag racing, and aviation.

8) Occupation - If your work increases the chance of death, you will be charged more for coverage. An office job won't affect this, but industries such as construction, roofing, certain types of police work, firefighting and others can cause your premiums to increase.

9) Driving and criminal record - If you have a reckless driving record with DUIs, a suspended license or frequent traffic violations, you are seen as a higher risk and will pay more for coverage. If you have a criminal record, you will pay a higher premium or not be eligible for coverage at all.

Once you have determined how much life insurance you need by conducting a LIFE needs analysis, you need to decide whether to buy term life insurance, permanent life insurance, or a mix of both to get the coverage you need.

Term life insurance covers you for a set period of time such as 10, 15 or 20 years. If you die during that time, the policy pays out. If you do not die during that time, the policy ends. Permanent life insurance, such as whole life insurance, covers you for your entire life meaning that your death benefit will pay out no matter when you die. There are a couple ways to think through this.

1) Term is the cheaper option - If you simply want to get covered at the cheapest cost, term life insurance is best. Most term life insurance policies do not pay out which means that life insurance companies can charge a lower premium.

For example, if you buy a 20 year term life insurance policy when you are 30 years old, there is a good chance you will still be alive when you are 50 years old at which point the policy would end. Individuals often use term life insurance to protect their families when they are most vulnerable.

For example, let's say that you conducted a LIFE needs analysis and found that you need $2 million in coverage. You also found that your spouse who does not work would need $250,000 in coverage as they take care of your children.

If your children are young, you might only want to protect them until they are financially independent. If you assume that this is going to take 20 years, you could get a 20 year term policy with $2 million in coverage, and your spouse could get a 20 year term with $250,000 in coverage.

2) Permanent allows you to do more - Although term is cheaper, a permanent life insurance policy makes more sense for some individuals. First, permanent life insurance is guaranteed to pay out. Term life insurance will only pay out if you die during your selected term.

If you want a way to guarantee you leave your loved ones a lump sum of tax free money, permanent life insurance may be a good option. Beyond the death benefit, permanent life insurance has one other feature that you can use called cash value.

When you buy a permanent type of life insurance, part of your money goes towards the cost of insurance, part towards administrative fees charged by the insurer, and part into cash value. Cash value is a separate account that is part of your policy that earns a guaranteed interest rate.

You can use this cash value throughout your life in a variety of ways. This allows you to use a permanent life insurance policy while you are still alive. For this reason, some individuals will refer to permanent life insurance policies, such as whole life insurance, as an investment.

This is not the best way of thinking about permanent life insurance, but it can be part of a well rounded financial picture. The downside to meeting your life insurance needs through whole life insurance is that it is more expensive than term life insurance.  

3) A combination of both might be best - For some individuals, combining both term and permanent life insurance can be an ideal strategy to meet their coverage needs. For example, let's say that you do a LIFE analysis and find out that you need $2 million worth of coverage, and your spouse who does not work needs $250,000.

It might make sense to buy a cheap $250,000 term policy for your spouse to protect the work of raising your children. For your $2 million, you might buy $1 million in term and $1 million in permanent. The $1 million in term coverage would allow you to buy lots of coverage at a cheap cost.

You might buy a term policy to get coverage for major expense as you pay them off. For example, if you have a 30 year mortgage, you could buy a 30 year term policy to cover the mortgage for your family if something were to happen to you.

Once you have a term policy in place, you might buy the remaining amount of coverage you need through a permanent life insurance policy. This guarantees that your loved ones will be left money and allows you to use the policy while you are still alive.

Keep in mind that this is only a hypothetical scenario. The way you structure your life insurance needs will come down to your own preferences. Working with a competent life insurance agent will ensure you understand all your options.

The bottom line is that the exact amount of life insurance you should have will vary by your individual needs. You can multiply your pre-tax income by 10 to 15 times to get an estimate, but it is better to do a LIFE needs analysis to get a more accurate number. Once you have figured out how much coverage you need, it is best to buy a policy as soon as possible.

You can buy a term life insurance policy, a permanent life insurance policy, or a combination of the two. If you have life insurance through work, it is fine to take advantage of the benefit if your employer covers it. However, make sure that you have enough coverage through your own policies as it gives you more control.