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Buying life insurance provides important protection for dependents. But how much life insurance do I need? That's a difficult question to answer. This guide will provide insight into how you can determine the appropriate death benefit size.
The reason it's so difficult to determine how much life insurance you need is that the answer depends on the individual. Everyone has different levels of income and different financial obligations.
In general, the goal of buying life insurance is to fulfill financial obligations and provide support. You want to make sure you don't leave your loved ones facing financial disaster. To do that, it's important to consider the types of costs loved ones may need to cover when you die.
When you buy life insurance, it's a good idea to consider total outstanding debt. Paying off debt protects surviving family members from getting stuck with ongoing monthly bills they cannot afford to cover. Consider credit card debt, medical bills, and other outstanding loans when calculating total debt.
If you have a loved one who cosigned a loan with you, you may want to get enough coverage to pay off the balance. Depending on the loan agreement, they may be on the hook if you die before it's paid off.
Life insurance should replace income for as many years as loved ones would rely on your earnings. In most cases, a partner or children may rely on a stable amount of income coming into the household. The death of a breadwinner could be catastrophic without sufficient life insurance to replace the money that the deceased was earning.
Providing a large enough death benefit to cover mortgage costs helps to ensure that surviving loved ones can keep the family home. Since many people have joint mortgages with a partner or other loved ones, making sure the mortgage can be paid helps avoid a forced move or foreclosure.
The cost of a college education is astronomical and continues to grow. A death benefit that is large enough to provide for a child's education can help ensure kids have the resources they need until they're able to support themselves.
While it's helpful to take individual expenses and obligations into account, it's also worth considering several other approaches in determining how much life insurance you need.
Using a life insurance calculator is a quick and simple way to get a personalized estimate of the required death benefit. Many insurance companies make calculators available online. By inputting details about your financial obligations and goals, it's possible to get a rough estimate of the appropriate death benefit amount. However, if you want a more accurate estimate of your needs, consider working with a financial planner.
Taking a multiplier of income is one of the quickest and simplest ways to figure out how much life insurance you need. This could be a good approach for those getting preliminary quotes or who don't want to take the time to make a detailed assessment of financial obligations.
Many financial planners advise multiplying income by 10 to get an estimate of the appropriate death benefit amount. With this method, a person who makes $50,000 annually would need $500,000 in coverage. Some suggest a higher multiplier, such as 12 times annual income.
The DIME method is commonly recommended for determining how much life insurance to buy. It stands for:
By adding up the outstanding balance of debt; the balance on a mortgage; the amount of income replacement and the number of years it's needed for; and the estimated cost of education, you can estimate the financial needs of surviving loved ones.
If you have substantial assets loved ones could rely on after your death, you may not need to purchase as much life insurance. This is why comparing assets and obligations is another good approach to determining your life insurance needs.
Liquid assets are assets that can easily be converted to cash, such as investment accounts, certificates of deposit (CDs), and accounts receivable if you own a business. Financial obligations include mortgages, car loans, and other debts.
By subtracting your assets from your obligations, you can determine how much your surviving loved ones would need to fulfill any remaining financial responsibilities.
There are some other factors worth considering when deciding how much life insurance you need.
Life insurance premiums increase with a larger death benefit. As a result, it's important to compare life insurance costs to see how large of a death benefit you can afford. Even if you can't afford the ideal level of coverage, having some protection is better than nothing.
If you want to maximize your chances of getting the amount of coverage you need, don't wait to buy life insurance. Premiums rise as a person ages and the risk of death goes up.
One of the most common life insurance mistakes is focusing only on earnings when buying coverage and discounting valuable services. For example, if you're a stay-at-home parent or you care for a sibling or aging parents, you're providing valuable services. Your family may need to pay someone to provide these services if you die. It's important to buy enough life insurance coverage to pay someone to provide these essential services -- even if you have no income.
The median cost of a funeral, viewing, and burial was $7,848 in 2021, according to the National Funeral Directors Association. If your liquid assets wouldn't cover your funeral and final expenses, you want enough life insurance to cover these costs. In fact, when considering the best life insurance for seniors, you'll find some funeral policies that come with limited death benefits. However, these policies are available even to older people with the goal of ensuring their families aren't financially burdened by burial expenses.
Finally, evaluating different types of life insurance is important in determining coverage. Term life insurance provides a death benefit only for a limited time. Term life insurance is much more affordable, but it's not appropriate for people who will need lifetime coverage.
On the other hand, permanent life insurance policies, like whole life insurance, remain in effect indefinitely so they can provide better protection for those who will always need an insurance payout. It also accrues a cash value. You might opt for permanent life insurance if you want the proceeds of life insurance to pay for estate taxes or if you're a parent who's the caregiver to a disabled child who will need expensive lifelong care. Our whole life insurance guide can shed some light on whether this permanent coverage is most appropriate.
Whether $500,000 in life insurance is sufficient or not will depend on the policyholder's individual situation. Ideally, life insurance should provide a death benefit that's large enough to cover final expenses, repay debt, pay off a mortgage, cover a child's education, and replace your income for an appropriate number of years. In some cases, $500,000 will be the right amount to do that. In other circumstances, it may be too much or too little.
In 2021, the average death benefit for new individual life insurance was around $190,000, according to the American Council of Life Insurers.
The average cost of life insurance premiums varies substantially by age and coverage amount. For a 20-year-old male nonsmoker buying a 20-year term policy with $250,000 in coverage, monthly costs start at around $12, according to Quotacy. But for a 60-year-old female nonsmoker buying the same amount of coverage, monthly premiums start at about $74.
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