If anyone relies on your paycheck -- such as kids, elderly parents, or anthropomorphized pets -- then you need life insurance to replace that income if you get permanently laid off (if you know what we mean). But how much life insurance do you need?
Good question! And not an easy one to answer. Special circumstances, such as pre-existing medical conditions or tax-efficient estate planning, can significantly complicate the question of how much life insurance you need. The insurance industry itself throws out many different formulas.
We're going to boil life insurance down to its most basic purpose: replacing your annual income until the age you would have retired. Figuring out needs from this angle will do the trick for most people. (Alternatively, you could assume you're replacing income until your dependents no longer need support.)
Start with your current annual before-tax income. The other number you'll need is the time, in years, until you reach retirement age.
Given these two numbers, you can figure out how much your family will need to replace this lost income over this length of time should something happen to you. We've even have a Replacement Income Table to help you out with the calculations.
Looking at the table, you'll see that to replace $40,000 per year, in today's dollars, for 25 years, you should plan to leave your family a lump sum of roughly $803,000. Sound like a lot? Before you sell the goldfish and put the kids to work, you may want to tweak this number. For example, there are some factors that can reduce the amount of life insurance your family will need, such as Social Security benefits, your spouse's income, and your savings. Then again (yeah, this is the capital B-U-T), there are also some good reasons to increase the replacement income number.
For a ballpark number, though, the Replacement Income Table is a good start toward answering "How much life insurance do I need?" For step-by-step help with tweaking this number, visit our Insurance Center.
Finally, note that the breadwinner of the family is not the only person who should be covered by life insurance. If a spouse stays home to watch the kids and mind the domestic affairs, that spouse should be insured for an amount that would be enough to pay someone to perform those duties.