You recently started a new job. You became engaged or married recently. You welcomed a child into your family. You may not be thinking about life insurance because thinking about your morality is not fun. However, these are all examples of times to be thinking: How much life insurance do I need?
This topic is on my mind because along with updating our estate planning documents, we are currently updating our life insurance policies because I need some additional insurance for two reasons (you may be thinking 1. My oldest and 2. My youngest, but only part of that is right.).
- When I left my previous employer, I lost a life insurance employee benefit.
- In the last year, I went from one dependent to two. This means if I died today, the amount of money to take care of my dependents is higher than it was at the beginning of the year before she was born.
It is essential to have life insurance because life insurance is security and peace of mind for your family if the unthinkable happens.
So, while life insurance is on my mind, I put together this post, which covers the following:
- Who needs life insurance
- Life insurance types
- Which type of insurance is recommended in financial education
- Methods to obtaining life insurance
- Personal financial guidelines to answer the question, “How much life insurance do I need?”
Who Needs Life Insurance?
One in three consumers surveyed by LIMRA, a financial services research organization, in a 2020 consumer pulse survey said that their family would face financial hardship within one month if the primary wage earner died.
Additionally, 70% of respondents stated that they believed they “should own life insurance,” but only 50% of respondents actually carried life insurance.
First and foremost, not every person needs life insurance. However, I’d go out on a limb and say if you’re asking the question “How much life insurance do I need?” you likely need life insurance.
There are at least two categories that people fall into that need life insurance:
- They have dependents, and their assets aren’t high enough to care for the dependents if they are deceased.
- They have debts with other individuals, and the other individual(s) would be unable to pay off the debt without their support.
A Note on Not Waiting To Become Insured
While these are two categories, there may be additional reasons to become insured. One is based on just an overall want or need to have an all-encompassing financial picture. Perhaps you know you are planning to have children, health issues run in your family, etc.
One of my personal finance professors said that men need life insurance the day their child is conceived and that women need life insurance the day their child is born. While I think there are a number of terrible flaws in that thinking, here is just one of them: I have two babies. Do you know what I wasn’t thinking about on the days they were born? Life insurance.
I’ve had two close friends who have battled cancer. Do you know what neither of them anticipated? Battling cancer in their 20s.
Waiting until you need life insurance is not an option. You need to take out life insurance in anticipation of when you meet the criteria of needing it. Waiting until the day our daughter was born would be a little reckless and beyond inconvenient.
No one plans to become sick; no one plans to be in a car accident, etc. If you wait too long, you may be deemed uninsurable, your pre-existing conditions may be excluded, or your premiums may be so high that life insurance isn’t a realistic option.
So, my argument is that if in the near future you may fall into a category of needing life insurance there is no time like the present to figure out the answer to the pending question of how much life insurance do I need?
But, what kind of life insurance is the best option?
Types of Life Insurance
First, there are two types of life insurance:
- Term Life Insurance: Term life insurance is straightforward. A person pays a life insurance premium, and if they die, the death benefit will be paid out. Term life is written for a specific period or term (i.e. 10, 15, or 20 years). Term life insurance only has value if you die during the term of the policy. Term life insurance is less expensive than whole life insurance.
- Whole Life Insurance: Whole life insurance policies are policies for life, as long as you pay the premiums. Whole life insurance will have a higher premium for the same death benefit as a term policy would have. In return for the higher premium, the policy will build a cash value. If you choose, though, to access the cash value, your death benefit will decrease. Additionally, some life insurance will let you take a loan against the cash value, but then they will require interest when you pay the funds back.
Which Type of Life Insurance Should I Get?
In personal financial education, we say “buy term and invest the difference.” This is because term life insurance is much more affordable than whole life, and because the real purpose of having insurance is for a death benefit.
Life insurance is not meant to be an investment vehicle. Investing the difference in other vehicles, like the stock market (or certificates of deposit if they ever have any return in the future), will yield you a much better return in the long term.
Another reason financial educators recommend term life is because of the span of time life insurance is needed if practicing good financial habits. Remember, at some point you will have enough assets, have few debts, and will have financially independent children, so life insurance will no longer be needed.
How to Get Life Insurance
There are a multitude of ways to get life insurance. Let’s dive into each one.
First, your employer may have a life insurance employee benefit. Typically, employers offer a multiple of your salary (such as one or two times your base salary). This employee benefit is typically free.
Your employer may give you a supplemental option where you can purchase (through payroll deduction) additional life insurance. The cost is generally extremely low and there are usually few hoops to jump through (just fill out your election for the insurance) to get the insurance in place.
Second, if you are a member of a professional organization, you may be able to get life insurance through the membership. Typically organizations will negotiate with an insurance company. Because of these negotiations and the size of the membership population (law of large numbers can come into play), premiums are generally quite low.
Finally, you can go the private life insurance route. This is when you work directly with an insurance company on your own behalf. There are tons of commercials on television, etc. for these types of policies. It may be slightly more expensive and there may be more health questions at a lower death benefit level. However, term life insurance is still very inexpensive option.
How much life insurance do I need?
Ok, now to the question you’ve been waiting for. How much life insurance do you need?
In personal financial planning, there are three ways to determine how much life insurance you need:
- In-depth calculation
- Simple rule of thumb
- Factoring your dependents
#1. In-depth calculation
I’ll start with the most complicated way, so then you can forget about this option. Basically, the point is to create a calculation based on the liabilities you have, how much money dependents and their caregivers will need, and any other things for which you want to provide for financially if you were to pass away.
You then do a present-value calculation and determine the answer to “how much life insurance do I need.”
Anything that gets too complicated is just a barrier to getting something accomplished, so that’s why we don’t recommend going this route. There are tons of life insurance calculators online, but because there can be so many behind the scenes assumptions, MPower Co does not recommend any of them.
#2. Simple rule of thumb
Second, The most simple rule of thumb is to take some multiple around ten times your before tax salary. So, if you make $50,000 annually, $500,000 is the appropriate amount based on this rule of thumb.
#3. Factoring your dependents
Finally, another way to determine how much life insurance to carry is to estimate your earnings potential over the period you believe your dependents will be dependent on financial support.
So, to make this an example: A person has a five-year-old that they think will be dependent until 25 (I’m using round numbers here!), and you estimate your earnings potential is $50,000 each of the next 20 years. Using this rule of thumb would be to have a life insurance death benefit totaling $1 million.
So using the second method and this third method, it would make sense to likely have somewhere between $500,000 and $1 million in life insurance.
At MPower Co, we recommend calculating this range ($500,000 to $1 million in the example), and then look into your options and costs to obtain life insurance within this range.
Final Thoughts on How Much Life Insurance Do I Need
If you can’t tell from this post, I’m passionate about life insurance. I once sold life insurance as an internship. I’ve heard stories and I’ve witnessed how life can impact our loved ones and us unexpectedly.
If you have read this far and aren’t quite sure where to start, start by thinking about your life insurance needs range from the second and third rules of thumb and then find out what you can get through your employer. October is generally an open enrollment month, so you may be able to stop there.
If you cannot get to the threshold of life insurance that makes you comfortable, look into the other sources for getting a life insurance policy.
You will never regret doing something when it comes to having adequate life insurance. You will regret not having it if you need it later in life.
We are living in a pandemic that has killed over 213,000 lives in the United States alone. Medical experts expect there to be more cases and deaths through the winter. If the stories I shared earlier weren’t motivation, let that figure be.
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MPower Co is a mother-daughter owned and operated financial education company that incorporates positive psychology into our teachings. If you enjoyed reading this article or found it helpful, follow MPower Co on Facebook or Instagram. MPower Co posts current financial and positive psychology topics and shares new blog posts like this one once released.