How do you truly determine how much life insurance you need? Here is a helpful guide including a few questions to ask yourself when selecting a life insurance policy.
How Much Life Insurance Do You Really Need: A Rule of Thumb Analysis
Life insurance can be a large expense in your personal financial plan. Especially if you have double coverage or chose an expensive plan relative to how much you actually need.
When it comes to purchasing life insurance, one of the most important things to consider is exactly how much of it you need. Usually, millionaires understand how much they are paying for everything related to money and their succession planning.
But before we get into the qualifiers, let’s take a quick look at the two types of life insurance typically offered.
Types of Life Insurance
There are two notable types of life insurance policies that you need to know before determining how much you really need.
These types of life insurance policies are whole life insurance and term life insurance.
Whole Life Insurance
Whole Life Insurance is sold as a lifelong policy with a savings plan attached to it. The savings plan is what companies usually highlight when promoting this kind of life insurance.
It’s marketed as a savings plan that can be tapped into in emergency situations. Further, should you outlive the length of the policy — typically upon turning 100 years old – you have the choice to cash out in full.
For example, if you purchases a $100,000 life insurance policy and accumulated $125,000 in your savings plan, at the end of your policy you’d be able to withdraw one of those values.
Of course, by the time you reach 100 you may not need $125,000, or even the original $100,000 of your policy, to the extent you might’ve when you were younger. So while the company is obliged to pay this out to you, you’re still essentially paying $75,000 for life insurance you’ll never get to use.
Here’s the catch about whole life insurance. Sure, you’re able to “borrow” from your savings plan for unexpected costs and whatnot, however, you’re also expected to pay back what you borrowed—of your own money—at an interest rate of up to 8%. So in reality, this savings plan is hardly a savings plan at all.
Term Life Insurance:
Term insurance is life insurance specifically designed to cover a certain period of your life when you’re statistically likely to be carrying more debt. Usually this period is anywhere from 10-30 years, and the policy ensures your family will be covered should you die with outstanding debts.
Term insurance is more affordable because it only covers you for a specific period of time and offers no so-called “savings” programs. This is usually the reason why people choose whole life over term. However, the lack of a savings program should actually be considered a blessing.
One benefit of term insurance is that you get more coverage for less money, which means you can buy the policy and invest the difference.
For example, if your average whole life policy is a flat rate of $300 per month (much depends on your health score), your average term policy should be $100 per month or less, depending on your health rating. Since your term policy has a significantly lower premium than a whole life policy, you can take the extra $200 a month and put it into investments.
These investments are designed to:
- give you more return than a cash value or any other savings plan
- provide you access to your money in an emergency
- Allow you to double or even triple your policy value by the time it runs out.
These investments will enable you to become financially independent and no longer need life insurance to keep your family secure. These are several other core differences of term vs whole life insurance.
How Much Life Insurance Do I Really Need?
To determine how much life insurance you’ll need to ensure your family will be financially secure in the event you pass prematurely, the following factors need to be taken into account.
1. How much debt do you have?
First, gather up all of your deficits and bills including:
– Student Debt
– Credit Cards
– Auto Loans
– And any other outstanding debts and expenses
Next, Gather up all your assets including:
– Houses paid (but you likely won’t get full retail value)
– Cars paid
– Retirement Funds
– Savings Funds
To do the math add up all of your deficits and then do the same with your assets. Subtract the amount of your total assets from your deficits to determine the full extent of your debt.
Look at how much you owe in total and how much you need to pay out every month. You need to calculate the minimum amount of money your family will need to support themselves until all your debts are paid off.
A good rule of thumb is to take your income and multiply it by 17. This is how much money your family will need to live comfortably after you’re no longer around.
If you don’t need to cover them for the entire duration of their lives, you can multiply by five or ten depending on how long they’ll need to be provided for.
2.How many children do you have?
Another consideration is your dependants. How many children—or people under your care — do you support on a daily basis? You should always buy an extra $100,000 of life insurance per child in order to cover their college expenses should you pass early.
3. Can your spouse work?
If your spouse is unable to work or won’t be able to cover your entire salary on their own, you’ll need to calculate how much money they’ll need every month in order to maintain their current lifestyle.
Then, according to Forbes Business, “multiply that number by 25. That’s how much money you’ll need to leave your partner to provide for them financially.” Include your assets and savings funds into this so you don’t end up paying for more insurance than you need to.
See Related: How to Raise Your Credit Score by 200 Points
Conclusion on Determining How Much Life Insurance You Need
Life insurance is a numbers balancing game. Determining how much life insurance you need is actually great for financial planning — not just for the future but for right now.
Knowing where you stand on your debts and assets is exactly how you learn how to get on your financial feet. You can actually sell your insurance policy if you absolutely need to.
Investing in the right life insurance is important. We recommend buying term and working with an investor to find the investments that will set your family up for financial success for generations to come. There’s other forms of insurance available for you. For example, you can use Liberty HealthShare for shared health insurance services.
Do you have life insurance? What life insurance policies would you recommend? Please let me know in the comments below. I’d love to hear from you.
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