Life Insurance – How Much Do I Need?

Life Insurance

Life insurance is a key component of a sound financial plan, but it is one of those topics that is difficult for most of us.  We know we need life insurance, but it’s an uncomfortable subject to think about or talk about.  On top of that, it’s hard to know how much life insurance we really need.  As a result, too many people have no life insurance at all, or they are vastly under-insured.

I recently read a statistic that the average American has life insurance equal to three times their annual salary.  While this is better than having none at all, it is not adequate for the typical American family.  In this post, I want to address some things to consider in determining how much life insurance you need.  I’m not a life insurance salesman, so I’m not trying to sell you any insurance.  But I feel strongly that if you have family members who depend on your income, you need adequate life insurance.

There are basically two approaches you can use in determining the amount of life insurance you need.  One approach is to use one of the “rule of thumb” calculations.  The other approach is to try to make assumptions as to what you want your life insurance proceeds to cover, and then calculate an amount needed based on those assumptions.

Let’s look at these approaches separately.  One common rule of thumb is that your life insurance should be seven times the amount of your annual take-home pay.  So if your take-home pay is $50,000 per year, you should have $350,000 of life insurance.  (Take-home pay is used instead of gross pay, because life insurance proceeds are typically not subject to federal income and payroll taxes.)  Although this is not a bad rule of thumb, it’s important to remember that when it comes to life insurance, one-size does not fit all.  So it’s possible that this approach could leave some families under-insured, while other families might not need this much.  Still, if you have absolutely no idea how much life insurance you need, this might be a good starting place for your consideration.

Another rule of thumb I’ve heard is that you should subtract the age of your youngest child from 21, and multiply that difference times your annual take home pay to determine how much life insurance you need.  So if your youngest child is 10, you would subtract 10 from 21, leaving 11.  Then you would multiply 11 by your annual take-home pay.  Continuing with our assumption that your take-home pay is $50,000 per year, this calculation would suggest that you need $550,000 of life insurance.  This can be a good approach if your primary concern is to make sure your children are provided for until they reach adulthood.

Now, let’s look at the approach of calculating what you need based on what you want your life insurance proceeds to cover.  In using this approach, you will try to estimate how much money your family will need to maintain their lifestyle without you.  Remember to include additional costs they may face in your absence.  For example, if you have young children, child care costs will likely rise.  You may also want the policy to help fund their college education.  If you have debts such as a mortgage or car loans, you may want to make sure there is enough life insurance to pay off those debts.  You will also need to consider other sources of income, such as your spouse’s salary or pension, and any Social Security or other government benefits for which your family may qualify. 

Regardless of which approach you use, don’t let the difficulty or uncertainty of determining how much life insurance you need prevent you from actually getting it.  Remember, even if you get it wrong in determining how much life insurance you need, something is always better than nothing.  Life insurance is a vital component of your overall financial plan, especially if you have a family who depends on your income.  If you don’t have life insurance, or if you believe you are under-insured, take action now to remedy the situation.  Your family is counting on you.

Thank you for visiting our site and reading this article on life insurance. We appreciate your interest and invite you to read other articles on our site.