This Is the Amount of Term Life Insurance Dave Ramsey Always Recommends. Is He Right?

Here's what you need to know before buying term life insurance.

Life insurance is a vital purchase for anyone who doesn't want to create hardship for surviving dependents.

Those who have loved ones who rely on their income will want to buy term life insurance coverage to make sure the bills can be paid if an untimely death causes that income to stop coming while it's still needed. And people who provide services to loved ones, such as caring for kids or aging parents, will need to make sure there's money to pay for those services in case of death.

But how much life insurance should actually be purchased? This can be a complicated question, but finance expert Dave Ramsey has a simple answer.

Ramsey recommends using this approach to setting a death benefit

There are two questions a life-insurance buyer must answer. These questions are:

• How long should the coverage term be?
• How large should the death benefit be?

Ramsey recommends buying a policy that lasts for 15 to 20 years. He believes this is an appropriate length of time because, "That's long enough to give the kids time to grow up and (fingers crossed) get out on their own (meaning they're no longer dependent, they're independent!). It also allows you and your spouse time to build enough wealth to self-insure."

As for how much coverage to purchase, Ramsey also has a standard answer for that as well. He suggests purchasing a policy with a death benefit equal to 10 to 12 times income. So, a person who made $50,000 annually would need a policy equal to between $500,000 and $600,000.

The reason for this recommendation is because a policy of this size could be invested and produce a sufficient amount of funds to replace the income that was lost. "If you die, your family can invest the payout from your life insurance in good growth stock mutual funds with an average return of 10–12%. The growth of that investment alone could replace your salary for a long time. That gives your family a comfortable financial cushion while they grieve and recover from their loss."

Is Ramsey right?

Ramsey's advice is a good basic jumping-off point for people to get a rough idea of how much coverage they need. But it's not necessarily the best advice for everyone to follow because their individual needs can be so different.

A person whose kids plan to go to expensive colleges, for example, may need a different amount of coverage than someone with no kids. Or, someone with a higher-earning spouse would have different needs than a person who is a sole breadwinner for a family of five.

Instead of using a generic formula like 10 to 12 times income, it's best to consider the specifics using an approach called the DIME Formula. This approach involves purchasing sufficient coverage to:

• Pay off debt
• Replace income for the required length of time (ideally, using a more realistic estimate of how much returns investments can reasonably produce -- which is probably close to 7% to 8%)
• Repay the mortgage balance on a family home
• Cover educational costs for children.

That's where DIME comes from -- debt, income, mortgage, education. Taking this personal approach can help policyholders customize their coverage -- as can considering exactly how long loved ones will rely on their earnings when deciding on a term length.

So, while Ramsey's advice can help estimate coverage, these other alternatives are a better way of deciding on a coverage term and just how big the death benefit should be.