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How Much Life Insurance Do You Actually Need?

Life insurance is a marker of financial adulthood, but it can be hard to know how much life insurance you should have. Your needs depend on your personal situation.

Luckily, there are some guidelines to help you decide if you need life insurance and how much you need. 

What is life insurance anyway?

Simply put, life insurance pays specific people a set amount when you die.

Life insurance is a valuable financial planning tool for anyone leaving behind loved ones, debt, and/or lost income. It gives the people you leave behind a way to replace your income and survive financially without you. 

You purchase a policy from an insurance company. The death benefit, or the amount paid out upon your death, is usually a large amount, like $100,000. You get to choose who receives the money; that person is the policy beneficiary. Each month, you’ll have to pay a small premium, like $50, to keep the policy current. 

The monthly premium depends on the amount of death benefit, but also how likely the covered person is to die within the policy term. Older people or those with serious health conditions will have to pay a higher premium. Larger policies often require a health exam, and some conditions will make you ineligible for coverage at all. 

A life insurance policy is a way to leave large amounts of money to your family, for a relatively low cost. It would take 166 years to save $100,000 if you’re putting $50 cash in your sock drawer each month. I hate to break it to you, but you won’t reach that goal.

Why is life insurance better than investing?

Obviously, you could invest $50 a month and end up with quite a bit of money too… but that’s riskier. Investment returns are not guaranteed. 

It will take a long time to build up enough to support your family, and you might not live that long. 

The stock market is also unpredictable, so it’s definitely possible you could pass away during an economic slump. That’s a time where your investments will be less valuable.  

Finally, you have to think about taxes. While you’re alive, you’ll have to pay taxes on any interest earned on investments and on capital gains for investments you sell. An inherited investment account isn’t taxed until the investments are sold, which is nice for your heirs.

The best tax scenario is life insurance. Your beneficiary will not be taxed on life insurance proceeds. There are many more rules about taxes, so you should talk to a CPA if you’re really debating, but those are the basics that matter here. 

Types of life insurance

There are two main types of life insurance policies: whole life and term. Each type has its own benefits and drawbacks, as well as different fee and pay-out structures.

Whole life

Whole life insurance will pay the death benefit (as long as the policy is paid up) for the insured person’s whole life.  A whole life policy also kind of acts as a savings account; you can cash out the policy and receive a much smaller amount before your death. 

Whole life policies tend to be more expensive than term policies, for the same death benefit. You may be able to reinvest any dividends received from the policy or increase your death benefit at specific times. 

Most professionals recommend against purchasing a whole life policy because the monthly premiums are so high relative to the death benefit… basically, it will be expensive to get a large enough payout upon your death.

Term

A term life policy is only active for a set amount of time, such as 10, 20 or 30 years. Usually, they’re purchased by parents, to cover the time while their children rely on them. Once the kids are out of the house and you’re debt-free, you don’t really need the life insurance payout. 

The monthly premiums are much cheaper than a whole life policy when comparing the same amount of death benefit. The exact cost depends on the age and health of the insured – young, healthy people will pay less each month. 

Do I even need life insurance?

Like most financial things, the answer to whether you need life insurance depends on your situation. 

A single person with no family doesn’t need life insurance. 

A parent of young children needs life insurance. 

Parents of grown children, who still have debt, might need life insurance to provide for their spouse. 

There are many factors that should contribute to this decision, so it’s reasonable to discuss your needs with a financial professional. If you’re on the fence though, I always recommend just getting the life insurance. There’s a chance it’ll turn out to be a waste of money, but I love the security of knowing my family will be OK financially without me. 

How to decide if you need life insurance:

These questions will help you decide whether you need life insurance or not:

Do you have kids who rely on you for support? They could be under 18, disabled, or just need your help

Do you provide financial support for others?

Do you have debt (including a mortgage) that your family CAN’T pay off with savings?

Do you have a spouse with no retirement savings?

Would your family be financially unstable or even bankrupt without your earnings?

Are you a stay-at-home parent actively caring for children and contributing to running the household?

Are you lacking savings (in cash or a bank account) to cover funeral expenses?

If you answered YES to one or more of these questions, you need life insurance. After you pass away, your loved ones will be struggling enough. They don’t need to worry about buying groceries or paying the bills during such an awful time. 

How much life insurance you need varies, but it should pay off your debts, help your children pay for college one day, or just keep your family afloat financially. Who doesn’t want to provide that security?

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    Should I get a private policy or one through work?

    Once again, where to purchase a policy depends on your situation. I wish there were more clear-cut answers here.

    A policy through your job will be the most affordable, so this is a great way to just get coverage. Unfortunately, the policy usually is limited to your employment term. When you leave that job, you lose the policy. 

    Of course, you can always apply for a new policy at that time, but you’ll be older (and possibly in worse health). That means your premiums will increase, even if you were to buy an identical policy through your new employer. 

    So, if you’re confident your job is secure and long-lasting, buy a policy from work. If you can’t afford a private policy, buy one from work so you have the coverage. 

    But if you anticipate changing jobs or you have the budget to buy a private policy, that’s the option with the most long-term security. A private policy can be purchased for a lower rate when you’re young and healthy and kept through job changes. 

    Simple method to calculate how much life insurance you need

    If your financial situation is pretty simple, you can use this easy method for calculating how much life insurance you need:

    Annual income x 10

    This method replaces 10 years’ of your income. If there is any debt, the timeline decreases, assuming the debt is paid off. 

    This method probably doesn’t provide enough to pay off all debt including the mortgage, put multiple children through college, and allow your spouse to take time off or work less. 

    However, a simple financial life means the simple 10x method could be enough. I wouldn’t recommend this method unless you have no debt, no minor children, and no one heavily relying on you.

    Comprehensive method to calculate how much life insurance you need

    While researching, I was impressed with the ease of the DIME method. The acronym makes it simple to remember what needs to be included.

    The DIME method shows how much life insurance you need

    Add up your debt, income, mortgage balance, and education cost (for children) when purchasing a life insurance policy using the DIME method.

    Debt: non-mortgage debt + funeral expenses

    Income: annual income x number of years your family needs income (at least until youngest graduates high school)

    Mortgage: mortgage balance

    Education: estimate $100,00-150,000 per child for higher education

    Things that reduce insurance needs

    Cash savings and existing life insurance policies reduce the amount of life insurance you need. In fact, having multiple policies might be a good idea. You could purchase a relatively cheap term policy when you’re 25, then buy additional smaller policies as your income and expenses increase. 

    If you have significant cash savings, your remaining family can use those funds to live off of or pay off debt. In that case, you don’t need as much life insurance. 

    Do stay-at-home parents need life insurance?

    In most cases, stay-at-home parents DO need life insurance. They’re providing services that would cost hundreds or thousands per month to replace. If that parent were to pass away while there are young children in the house, the remaining parent definitely needs money to pay for those services. 

    How much life insurance does a stay-at-home parent need?

    A stay-at-home parent should have enough life insurance coverage to pay for:

    • Childcare until the kids are at least in high school
      • Transportation for children to school and activities
    • Housekeeping services 
      • House cleaning
      • Laundry
      • Grocery shopping
      • Personal assistant services like errands, scheduling, coordinating with schools, etc.
    • Funeral expenses
    • Debt payoff
    • Income replacement while the remaining parent grieves

    The remaining parent might have the bandwidth to pick up all of those duties, other than childcare. However, many parents stay at home because of their spouse’s demanding or unpredictable work hours. 

    A job like that makes single parenthood more difficult. Having sufficient funds will make the transition a little easier. 

    Do kids need life insurance policies?

    No one wants to think about losing a child, but it’s always a possibility. If you don’t have enough liquid savings to pay for the funeral, you should have a small policy on each child. 

    Liquid savings refers to funds that you can access easily, like cash or a savings account. It can take a long time to sell investments, real estate, or vehicles, so they’re non-liquid assets. 

    How much life insurance should I carry on my kids?

    A funeral can cost $10,000, according to Credit Donkey. An adult funeral costs approximately the same as a child’s funeral.  You can obviously save on funeral expenses to some degree, but I like to include a little extra death benefit. 

    When you lose a child, you’re not going to want to go back to work right away. Having a cushion will give you time to grieve. 

    Life insurance is a safety measure, to protect the people you leave behind. 

    Additional Source:

    https://www.investopedia.com/articles/pf/06/insureneeds.asp

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