Congratulations you have taken the first step to protecting your loved ones by deciding that you have a need for life insurance. You may have asked yourself “How do you determine how much life insurance you need?” In the guide below we will walk you through the steps to know the answer to that important question. How much life insurance do I need?
Multiple of Income Approach
Probably the most simple life insurance calculator is the multiple of your income method. Probably the most popular from the talking heads like Dave Ramsey. Take your annual income and multiply it by a factor often times they chose 10 as it is a nice round number. You can modify this pretty easily and use the number of years you plan to continue working, or the number of years left on your mortgage etc.
While this is quick and easy it is not very detailed and does not take into account any of the things you have going on in your life. Lets face it you are your own person, you have your own needs. You are not a robot and your needs are not cookie cutter. Do you have kids? Do you have debt? Do you have a small fortune in the bank? What about the stay at home parent that doesn’t have an income to calculate from?
Human Life Value Approach
This method takes a little deeper dive into your specific situation. It is a little more complex and takes more thought to calculate, but is more detailed. There are main things to consider when calculating your life insurance needs this way:
- Estimate your reaming lifetime earnings. You want to account for future raises as well. Are you taking a course and anticipate an income boost? Use that in this calculation.
- Now consider that there are some things and expenses that would not continue if you passed away. These are things like the taxes from your income 25%? 30%? You don’t get to keep that money anyway. What other expenses would discontinue?
- How long do you need to provide this income to the surviving spouse? Retirement? Till the kids are through college? The duration of a mortgage obligation?
- Optionally determine an estimated rate of interest you feel is conservative for growth. This will very depending on how comfortable you are with risk and managing investments. Keep in mind if you are the financial guru in your family and your spouse is not… They may not be as comfortable with such topics.
Put it all together. Take the net salary needed by the number of years needed, that is the your future earnings. Use that figure with the assumed rate of return to calculate the present value of the future earnings. For example a 35 year old that earns $60,000/yr. Using 70% the need is $42,000. They would need the income for 30 years. Assuming a 3% return (at the time of writing this banks are paying 1.25%) the need is $519,100. Seems like a complicated way to go about things. And what if you need to use the money?
The D.I.M.E Method
Perhaps the best balance of simple to follow but detailed approach. The DIME formula is an acronym for Debt, Income, Mortgage, and Education.
Lets start with Debt. We all know how hard it is to get out from under debt. Even with 2 incomes many families struggle to manage debt. What would that magic number be to pay it all off today? The D also stands for Death. What amount do you estimate a funeral would cost? Add that to your debt number and we have the D covered.
You can probably guess this one. Income is the amount of income needed multiplied by the number of years the income will be needed. Again this number will be different for every one. Using the same concept from before maybe you need income for 18 years till your toddler is out of high school? 30 years from retirement?
M is for Mortgage. How much would the check have to be to erase your mortgage? That is the number you want to put here. Imagine how much less stress you would have if you didn’t have to worry about that pesky house payment anymore.
E is for Education / everything else. Not everyone that has a need for life insurance has children at home. And not everyone with children at home believes in paying 100% of their education expenses. For this we want to look at how many children to you have? Do you want to pay all of their college? Do you want top pay for private or public education? Consider the difference of in state and out of state? The average education cost is from $25k to $52k per year!!!
How Much Life Insurance Do I Really Need?
Now that you have done the math lets break it down. Let’s take a look in on the typical American family. Jack and Diane have two kids a son that is six and a daughter that is three. Jack has been at his sales job several years and does pretty well. He earns $75,000 a year. Diane is a stay at home mom since their son was born. She plans to stay that way until their daughter is in school full time.
Like most couples they have a balance of $160,000 on their mortgage. They have one care loan for the family van for $14,000. They do a pretty good job with their spending but Jack had a slow month and they put some things on the Credit Card to make ends meet. Nothing too bad but they owe $3,200.
Jack has some life insurance through his employer but it is only one times his annual pay. Diane has none since she isn’t working. They have a little nest egg put away with $15,000 in it and another $6,000 in the kids college funds.
What might Jack’s need look like?
- Jacks income is needed for 20 more years. $75,000 X 20 = $1,500,000.00
- $160,000 for the mortgage
- $14,000 + $3,200 in debts = $17,200
- $100,000 they want to contribute to college. They want the kids to work for half
- $8,000 for an average funeral
This works out to $1,785,200.00!!! Yikes! But we haven’t subtracted the coverage from work or the savings yet.
- $1,785,200 but we only need 70% of that after taxes.
- $1,250,000 – $75,000 policy at work
- $6,000 from the college savings and the $15,000 brings us down doe $1,150,000 or so
This is pretty good plan with no debt and a paid off home Diane could continue to have a $52,500 annual income. The kids college would be taken care of as well. They could leave the income at 100% if they wanted to help make up for not contributing to a retirement account. Once the kids are teenagers she could go back to the work force like she planned all along.
What might Jack pay for a plan like this?
Let’s not go crazy and look at the bargain basement pricing. Let’s say Jack is 38 doesn’t smoke, but he has high cholesterol and could stand to lose 15 pounds he would probably be a standard plus rate (preferred some places).
For his $1,200,000. need a 20 year term policy is just over $1000 a year. A little over 1% of his income will guarantee his wife and kids the life they dream of. Spoiler alert, if he takes great care of himself his premium would be as low as $600 year!
What about Diane? She might not be bringing an income into the bank account from a paycheck, but she still has a lot of value! She is the love of Jacks life for one. And just how would Jack continue his career without the peace of mind that the kids are safe and sound?
- We would still want to relieve Jack from the mortgage $160,000
- They calculated child care would be $100,000 if Diane were not able to do it
- Taking care of college is a priority for her as well $100,000
- $8,000 for final expenses
- They decide paying off the debt is a good idea as well $17,200
This comes to just under $400,000.00 You could easily make the case that Jack might need to take some time away from work to cope with the loss of his spouse. So let’s see what it would cost to take care of Jack? For Diane I used Preferred rates. She stays in pretty good shape chasing those little ones around.
Recalculate When You Have Major Changes
Life throws us a lot of curve balls. What is right for you today may not be the right plan later on . There are many types of policy options. We get a lot of questions about the types of coverage available. And the appropriate policy type can change from one stage of life to the next. The most important thing is to have the coverage your family needs if they need it.
Many times people are surprised to see the amount of life insurance that is right for you. It can be a shock to the system to see a $1 Million need even on a modest salary. Don’t get discouraged rates are as low as they have ever been for life insurance. We even have some tricks to keep the cost as low as possible. Get your custom quotes instantly on this page by putting your calculated amount into the box. We will reach out and give you a personal quote for your situation. We make sure to match you with the best company and policy for your needs. As a life insurance broker we work with many of the best companies, don’t get stuck with the flavor of the week from the other guys.
Come back and recalculate your life insurance needs anytime. Get a raise? Have a child? Purchase a new home? Pay off your home? Start a business? Wake up in the middle of the night and wonder to yourself “How much life insurance do I need?” There are so many reasons to review your coverage options. We will be here to help when you have questions. Some policies are even flexible from the start. You can actually have more than one life insurance policy. Many people are surprised to learn that. You can keep your existing policy in place and take advantage of the great rates you already have. Or maybe a second policy isn’t best, maybe you would be better to combine and get the bulk rate pricing? We have helped thousands of clients determine just what is best for them. We can walk you through it too.
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