The primary purpose of life insurance is to act as a safety net, to ensure loved ones have the financial resources to care for themselves after you’re gone. However, life insurance needs change over time and you may find yourself wondering how much coverage you should carry at various stages in your life.
While you’re young, you may want a lot of coverage because you likely haven’t had the time to build up retirement savings. However, your financial situation after retirement will likely look much different. If you’ve saved a lot throughout your life and have sizable savings, you may not see the need to carry a lot of life insurance because premiums can be expensive.
No matter what stage of life you’re in, we’ve created this guide to help you determine how much life insurance you need.
Methods to Determine How Much Life Insurance You Need
You should speak with a life insurance agent for the most accurate assessment of your coverage needs, but for a quick analysis — here are three methods to calculate how much life insurance you should have.
1. Multiply your household income by 10
The most basic calculation you can do to get a rough idea of your coverage needs is multiplying your household income by 10. This includes your income and a partner if you share finances. So if you and your partner have a combined household income of $130,000 — you should have at least $1.3 million in life insurance coverage. When using this method, it’s also recommended to add an additional $100,000 per child in the household if applicable. So if the couple above has two kids, they should add an additional $200,000 for a total coverage of $1.5 million.
This method is commonly shared online because it’s incredibly easy and fast, but it may be inaccurate to your actual needs depending on how much money you’ll need to maintain the same standard of living.
2. Use the Standard of Living Method
The standard of living method aims to provide an amount of coverage that would allow beneficiaries to maintain the same quality of life after the policyholder passes away. The method is relatively simple — calculate the amount of money beneficiaries would need to maintain their quality of living (usually by estimating annual expenses including housing, food, entertainment, etc…) and multiply this amount by 20.
The idea is that policyholders could withdraw this balance from the death benefit, and invest the remaining principal to hopefully break even or grow the sum each year. This calculation may also be known as the Human Life Value approach.
3. Use the DIME formula
DIME is an acronym for Debt, Income, Mortgage, Education — the formula works by adding up all of these financial obligations to get a more comprehensive view of your financial situation. To use it, follow the guidance for each variable:
- Debt: Add up all outstanding debts, excluding mortgage and education loans if applicable
- Income: Estimate the number of years your family would need financial support following your death, and multiply your household income by this number
- Mortgage: Determine how much money you’ll need to pay off your mortgage (if applicable)
- Education: Calculate the cost of paying off existing student loans, or future education expenses for children including private school tuition or college
Once you have all of these figures, add them all up and you’ll get the amount of coverage you should have. While this method will give you a more accurate assessment of your life insurance coverage needs, it doesn’t account for the savings you already have so it’s still not reliable on its own.
What to do if you have too much coverage?
If you did these three methods or spoke with a life insurance agent and realized you have far more coverage than you need, it’s time to scale back. If you’re young and paying too much, talk with your life insurance company about adjusting your plan to lower your premiums. If you’re past retirement, you may consider canceling or surrendering your coverage — but doing so would be leaving a lot of money on the table.
By canceling coverage, you’ll get nothing back. By surrendering, you’ll get a single low offer from the insurance company. Instead of these options, consider selling your policy through a life settlement where you can get 4-11x more than the surrender value. By selling your policy, you can get multiple offers from interested third-party buyers which raises the value you’ll receive. Contact us to learn more about selling your life insurance policy!