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.
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: $_________
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:
- 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.
Most people get some form of life insurance coverage from their employer for free, but how do you know if that coverage is enough? First of all, hats off to you for even asking that question! Most people keep the box checked for their employer-based coverage and then forget about it until open enrollment rolls around next year. You’re asking a critical question and you’ve come to the right place! Let’s dig in.
How Much Life Insurance Do I Actually Need?
According to PolicyGenius, 57% of Americans have life insurance, and of those people, 32% only have group life insurance (the kind offered by your employer). Fortunately, you’re in the same boat as a lot of Americans. Unfortunately, group life insurance is usually not enough.
But first, let’s understand how much coverage you really need. Nerd alert: the word “coverage” is often used to talk about how much money you want “covered” i.e., $250,000 or $500,000; however, this is technically called the “death benefit.” A death benefit is the amount of money that goes to your beneficiaries in the case of your untimely and heroic death. It’s important to select your beneficiaries—otherwise, the law will decide for you (#thanksbutnothanks).
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How Does Employer Coverage Work?
Okay, back to coverage. Like I mentioned, employers usually cover a small amount of life insurance for free as part of your benefits package. This is typically the equivalent of your salary or just a smidge more. We call this basic group life, and since it’s free and generally doesn’t require any medical exams, it’s a good idea to just click “check” on this box.
The equivalent of your salary in life insurance may seem like enough; however, when you really dig into the costs of end-of-life arrangements and all the monetary ways your family relies on you, that coverage can come up short pretty fast. That being said, people in different life stages and circumstances need different amounts of coverage. Here are the cliff notes (spoiler alert – we will talk about death):
- If You’re Married: This is a good time to look at how much coverage you each have because you’re likely to take on bigger financial commitments together. If one of you passes like an angel in your sleep, how will you afford those new house payments? You may need substantial time off work to hire a therapist, order wine by the case and cope with a new normal—could you afford to live off his/her group coverage alone? Make a really sexy date night soon to talk about how much coverage you have existing between the two of you, and how much you’d actually need/want.
- If You’re a Parent: When it comes to life insurance coverage, what do you want your kids’ lives to look like after you’re gone? Do you want their school paid for? Do you want your spouse to be able to stay at home with the kids for a long period of time? Try guesstimating how much this would cost and seeing how short your existing coverage comes. The gap between what your family would have versus what they will need is the amount you should look into for supplemental coverage—or buying an individual policy for that full amount.
- TIP: Don’t let the thought of price freak you out. It’s generally cheaper than most people think. Here’s a handy chart from NerdWallet with a breakdown of average life insurance rates for men and women.
- If You Are/Have a Stay-At-Home Spouse: Coverage is just needed for the breadwinner, right? Not so much. Take a second to think of all the things you do as a stay-at-home spouse. Did you list household cleaning? Laundry? Driving kids to and fro? Salary.com determined using its Salary Wizard that the median annual salary of just being a parent in 2018 is $162,581. Point is if you were gone, those things would most likely need to get hired out, at least until your family is back on their feet. This is why even stay-at-home rock stars need life insurance coverage.
- If You Have Student Loans: You may be wondering what happens to your student loans if you pass away. That really depends on the type of loan. Generally, federal loans are forgiven upon your death; however, private loans are a little trickier, and these would fall to the responsibility of your co-signers or spouse to pay. Even if the balance is forgiven by your lender, there may be substantial tax costs. Check your policy’s terms to determine if you’ll need extra coverage to cover your student loan.
- If You Have Credit Card Debt: If you die with credit card debt, that debt does not get forgiven. It generally will go to your estate to get paid, which includes any assets at the time of death, like property or savings. If there isn’t enough in the estate to pay off the debt, then the credit card company is out of luck, but any joint account holder would be responsible for any unpaid bills. While life insurance coverage can’t be garnished specifically for debt payments (unless you have the estate listed as your beneficiary), it can help your family recover from the financial loss to savings and other assets resulting from debt payoff.
- If You Have a Side Hustle: Does your family depend on the extra income from your side hustle? You might want to consider upping your life insurance coverage to include income from that lucrative pet-sitting gig of yours.
General Rules of Thumb to Determine How Much Life Insurance You Need
All in all, the most accurate way of calculating how much coverage you need is by sitting down and hashing out your household expenses, responsibilities (those things you need to be able to pay), and wishes (the preferred lifestyle for your family). But, just in case you’re more of an “eyeball it” type of person, the general rule of thumb is that your death benefit should equal 7x to 10x your annual salary. My rule of thumb is to use that as a starting base, but do the homework to make sure you’re getting what your family actually needs—and not paying for more.
Where Can You Get More Life Insurance Coverage?
So, you crunched the numbers and need more coverage. What do you do? There are two main options: 1) Buy supplemental group life insurance through your employer, or 2) buy an individual policy through another insurance company. When should you choose one over the other? Let’s take a look.
Supplemental Group Life Insurance
Pros of Supplemental Group Life Insurance:
- Convenience: No shopping around needed.
- Rates: Group rates can be especially competitive for those not in the best health that might get higher prices individually.
Cons of Supplemental Group Life Insurance:
- Portability: If you decide to leave the company or get fired, your coverage also goes away. In some cases, you can convert that coverage to an individual policy, but you’ll most likely end up paying more.
- Rates: Yes, this can also be a con, especially if you’re young and healthy. You may be able to find cheaper rates than the existing group rate.
- Medical Exam: Higher amounts of coverage will often require filling out an “evidence of insurability” health questionnaire, which could also lead to a medical exam. (You’d most likely be doing this for individual life insurance too, so it’s kind of a wash on this point.)
Individual Life Insurance
Pros of Individual Life Insurance:
- Portability: since this policy isn’t tied to your employer, you’ll have coverage wherever you go. Can you hear me now?
- Rates: As mentioned, if you’re young and healthy you might find cheaper rates than group coverage.
- Options: Term life insurance is usually what’s offered through an employer, and while that’s recommended for the majority of people, if you’re looking for whole or universal life, you’ll have that option.
Cons of Individual Life Insurance:
- Homework: You’ll have to do some shopping around for pricing and companies you like (but, well worth the time and effort).
What’s the Bottom Line about Supplemental Life Insurance?
Okay, you’ve gotten to the end of this post and really just want me to tell you what to do? Fair is fair. Here are three steps to understanding what you should do about that supplemental life insurance:
- Go ahead and take your employer’s base coverage.
- Then, find time to sit down and calculate how much coverage you really need based on all of the wonderful tips above.
- Shop around. PolicyGenius has a great tool to compare quotes. Ask yourself, for the coverage you need, who has a better price? Your employer or a different company?
Bottom line is that you’re a straight-up hero for taking it upon yourself to learn more about life insurance coverage. Hopefully, this post gave you the confidence of a thousand Justin Biebers to make the right decision for you and your family. Figuring out how much extra life insurance coverage you may need is highly personal, but can make all the difference for your loved ones. (Cue As Long as You Love Me). Now, go ahead and join the waiting list to be notified when we officially launch.