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How Much Life Insurance Do I Need?

Ashley Haugen

Ashley Haugen
October 24, 2019

So you’re starting to think about life insurance (awesome!) and wondering, “how much insurance do I actually need?” Great question. In this post, we’ll cover all the things you need to consider when looking at life insurance coverage and life insurance cost. It all starts with a “simple” equation. Read on to find out more!

But First, What’s a Death Benefit?

When looking at the cost of life insurance, you’ll come across something called the “death benefit.” This is often used interchangeably with the word “coverage” and is essentially the main purpose of life insurance. The death benefit is the amount of money your beneficiary(s) get paid upon your death. The amount of life insurance you purchase is essentially figuring out what this sum would be. So, for example, if you buy a $500,000 life insurance policy, in most cases, that means the insurer will pay $500,000 to your beneficiary if you die while the policy is active.

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That being said, there are some extra components to Whole Life Insurance, which also includes an investment option that can influence the death benefit amount. For the sake of simplicity, we’ll primarily talk about Term Life Insurance in this post, which is a more popular choice for young couples and families. If you want to learn more about the difference between Whole Life and Term Life insurance, check out this post.

A “Simple” Equation to Figure Out Your Coverage Needs

Alright, let’s get to the nitty-gritty of how to calculate your insurance needs. There isn’t a hard and fast rule for calculating your coverage amount, so it’s going to take a bit of elbow grease on your part. Mainly in the form of sitting down and figuring out how much money your family would need to keep things afloat and maintain the lifestyle you’d want for your family after you’re gone. Distilled down, the equation looks something like this:

((Annual Income + Annual Incremental Financial Obligations) x How Many Years Your Family Needs Financial Support)) + Desired Lifestyle – Assets = Coverage Amount

I know that may trigger some algebra-induced shivers, but it’s not as complicated as it seems. Let’s break it apart…

Income You Need to Replace

This is your before-tax annual income amount. Pretty self-explanatory. In a nutshell, if you’re gone that means your income is gone, too. Your family can use the death benefit as a way to cover your income.

Annual Income $________________

Incremental Financial Obligations

These are things like bills and debts. Figuring out this number depends on how you answer this question: Between you and your partner, does your combined income cover expenses like paying off credit cards in full every month, paying the mortgage/rent, utilities, and other must-pay expenses? If so, you may not need to factor in this category since your income covers it (and you’re already taking that into consideration above.) However, if you answered “no” then you’ll want to add on this amount. So, for example, if my spouse and I are having trouble making ends meet and we can’t routinely make a payment on an expense, we’d want to factor that amount into our coverage. Alternatively, you could decide to just pay off the student loan or mortgage in full with your death benefit, which we’ll talk about in “Desired Lifestyle” below.

Extra Must-Pay Expenses (Annual): $___________________

How Many Years Your Family Needs Support For:

But first, we need to figure out how many years you’d want the death benefit to last. As our equation stands right now, if you just calculate your annual income + extra financial obligations, you’ll only get your coverage needs for one year. We need to multiply this number by how many years your family will need to rely on your death benefit. Many financial professionals recommend a minimum of 5 years, and others recommend coverage until your kids are 18 and can start supporting themselves. If you don’t have kids (or they’re older), some professionals recommend getting enough insurance to support your spouse until they hit retirement.

Bottom line is, it really depends on what you can afford. The more years your family needs coverage for, the more expensive your premiums will be. That being said, any coverage is definitely better than no coverage, so even just starting with 5 years is better than nothing.

Years:  ____________________

Desired Lifestyle:

Okay, and now we get to our final part of the equation—lifestyle. This is last for two reasons: 1) It’s optional and 2) these are things usually calculated most easily as a lump sum and so shouldn’t be multiplied by how many years you need coverage to last; it’s just one number added onto your total.

Part of figuring out how much life insurance you need is determining what kind of lifestyle you want your family to have after you’re gone. For example, do you want your kids’ college education to be paid for? Do you want to pay off the house? Perhaps you want your death benefit to help pay off credit card or private student loan debt (federal student loans are forgiven upon the borrower’s death). Again, a lot of this will come down to how much you can afford, but if you want to take these things into consideration, add them to your total.

(Optional) Amounts for House/Car/Debt/School: $_________

Liquid Assets

After adding up all of the above, you’ll want to subtract the amount of liquid assets you personally have. Liquid assets are things that can be readily converted into cash (or cash itself).

Examples of liquid assets include:

  • Cash
  • Savings account
  • Certain investments like stocks, bonds, mutual funds, and money market funds

Amount of Liquid Assets: $_______________

Putting the Equation Together: How Much Can You Afford?

Okay, take all the numbers you have from above and fill out the equation:

((Annual Income + Annual Incremental Financial Obligations) x How Many Years You Need Coverage)) + Desired Lifestyle – Assets = Estimated Coverage Amount

Then, use a quote calculator like this one to put in your desired coverage amount and see how much your premiums would be. This will help you figure out how much life insurance will cost. Try playing around with different coverage amounts to find a number that still hits your needs but fits within your budget. Ultimately all of this can help you figure out how much life insurance you need. While you’re at it, join the waiting list to be notified when we officially launch.

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