Can You Have Too Much Life Insurance?

Wasting money on unnecessary insurance coverage could affect other financial goals.

Buying life insurance is an essential purchase for anyone with people depending on them. It's important to have enough coverage to offer full protection for loved ones. But, while buying a sufficient amount of insurance is crucial, policyholders also don't want to get too much insurance and end up spending more than necessary on premiums.

Here are two possible ways a consumer could end up with more life insurance than they actually should be buying.

1. Getting a death benefit that's too large

Every person who buys life insurance is likely doing so to ensure their loved ones avoid financial hardship. As a result, it is important for policyholders to make sure their death benefit is large enough. The death benefit will need to cover their funeral costs, replace their income, and pay for other needs the family has, such as covering mortgage costs or college tuition for surviving children.

But a larger death benefit isn't always better. The goal isn't to leave surviving family members with tons of wealth, but rather to make sure they can maintain their standard of living if the policyholder passes away early and unexpectedly. Buying too large a death benefit is unnecessary and can result in premium payments that are much higher than they should be.

To determine how much life insurance coverage is needed, there are several different approaches consumers can take. They can use a calculator offered by insurers; take a multiple of a current salary, such as 10 times the amount the policyholder makes; or use the DIME formula and buy sufficient coverage to repay debt, replace their income, pay off a mortgage, and cover educational costs.

Don't buy more than what these formulas specify is needed unless there's a specific reason to. Otherwise, insurance could become unnecessarily expensive.

2. Getting covered for more years than necessary

Most people do not need life insurance forever. Instead, they need it for a limited period of time while people depend on them to provide income or services.

For example, a young parent may need life insurance for 30 years until their children are grown, their own home is paid off, and they would be leaving the workforce anyway to rely on retirement savings. At that point in their lives, it's likely that no one would be dependent on their income anymore.

Buying insurance coverage for a longer term needed can result in higher premiums. And opting for whole life coverage instead of term life coverage would definitely be more expensive.

Whole life policies not only charge higher premiums because coverage is designed to last indefinitely, but premiums are also higher because there's an investment component to the policies. The premiums are for more than the actual cost of covering the policyholder, and the difference is invested -- but, unfortunately, the fees are high and returns are often lower than what would be available from other investments.

It is definitely possible to have too much insurance if policyholders buy coverage for longer than needed, or get a higher death benefit than necessary. Avoiding these two mistakes is important to keep life insurance costs reasonable while getting the protection loved ones actually require.