According to LIMRA’s 2011 Life Insurance Ownership Study, only one-third of Americans have individual life insurance coverage. While 56% of all workers have group life insurance through employers, that’s still a somewhat dismal number.
It’s clear that more families need the financial protection that life insurance offers. Remember: Life insurance is about protecting a family in the event that someone integral to the household passes on. This means that you need some sort of life insurance for your own family’s protection.
How Much Life Insurance Do You Need?
Figuring out how much life insurance you need requires a bit of thought. There are rules of thumb that suggest you get seven times or 10 times your annual salary. But if you want to be a bit more precise, think about how much money your family would need to cover the lack of your income.
Some consumers prefer a calculation that allows their family to use the lump sum insurance payout to create income indefinitely. One rule of thumb is the 4%, which means that your family lives off the interest from your payout, and assumes that the lump sum earns 4% a year. If you make $45,000 a year, you would need $1.125 million in insurance coverage to generate your salary.
Of course, you don’t know that your family will be able to net 4% a year, considering market conditions and inflation. The money might run out over time, but this can give you a fairly quick way of determining how much life insurance you might need.
Another approach is to add up the cost of all of the expenses you expect your family to need to cover for a set period of time. You might decide that you want your life insurance policy to pay off debts that you have, as well as your mortgage, so that your family doesn’t have to worry about these obligations. If you have a life partner that works, or that can get work, replacing your income doesn’t seem as important as providing a way for your family to get financially squared away.
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Also, consider how long your partner will have to support your children after you are gone. You can get coverage that will allow your youngest child to reach age 18. So, if your youngest is a baby, you might decide to get a 20-year term life policy (a little extra wiggle room). Then, you can add up what you hope to pay off with a life insurance policy. Your list might look something like this:
- $185,000 mortgage
- $7,000 car loan
- $20,000 student loans
- $6,000 credit cards
- 18 years x $45,000 = $810,000
- $5,000 funeral cost
The total by this reckoning is $1.033 million. Your family can pay off the bills, and then put the remainder into an account to draw on as income replacement. With earned interest, the money should last more than 18 years, although it wouldn’t last indefinitely.
If you are confident in your partner’s ability to earn a living, you might just decide on a number like $500,000 to cover expenses and pay off debts, and maybe contribute to your children’s future education.
At the very least, though, you want to buy enough coverage to pay funeral expenses and pay off debt. That way, your family has fewer things to worry about.
What do you think is the best way to determine how much life insurance a family needs?