My first policy was a $250,000 30 year term life insurance policy and I thought that was plenty. It was not until we had our first son that I quickly realized that was not nearly enough.
After his birth, I decided to increase it substantially. That was over two years ago. With us in the process of building our first home and a second son on the way, I’m left wondering even with that increase if I really have bought enough life insurance.
Update: We now have our third son and I have increased the amount of life insurance I have on myself. Check the end of the post to find what I’ve increased my term life insurance to and my rationale.
I know many struggle with this same decision so I wanted to shed some light how much life insurance is enough.
First things first, life insurance is for one purpose: income replacement. While there are times where life insurance can aid in more complex estate planning strategies, a majority of the time it’s purchased to take care of your family once you’re gone. My reasoning for purchasing life insurance is that I want to leave my wife and kids without any debt and the ability for my wife to not worry about finances in the event of my unexpected passing.
Life Insurance Coverage to Buy Rule of Thumb
As you can imagine, how much life insurance you need to buy will differ for each person. As a general rule of thumb, it will be a multiplier of your current income based on your age. To illustrate here’s an example that you can use:
Life Insurance Needs Analysis
To determine how much term life insurance you need, you need to perform a needs analysis. Here’s a step by step guide to calculate how much insurance you might need.
- Total annual needed by your spouse and children in the event of your death.
- Number of years you would like to provide this income to your spouse or children.
- Your gross income annually.
- Your date of birth.
- Your spouse’s gross income.
- Would you like to pay off any outstanding debt? For example, mortgage, loans, credit cards, college. If so, enter the debt amount.
- Burial expenses. That can include funeral, probate, and any other legal matters.
- Total amount of your existing life insurance.
- Interest rate assumption. This assumes the interest death benefit proceeds are invested.
Life Insurance Coverage Example
To help illustrate how much life insurance you might need to buy, looks look at an example. First, let’s consider some assumptions. We’re looking at a 30 year old male who makes $100,000 a year. He wishes to give his wife a $75,000 a year income for 30 years if he were to die unexpectedly. We’re also assuming that the wife works and makes a $35,000 a year income. The final assumptions is that there is $400,000 of outstanding debt to pay off (for example, a mortgage and student loan debt), $10,000 for burial expenses and a 6% growth rate on the proceeds.
Term Life Insurance Amount Needed
Based on the above assumptions, the husband would need to buy $993, 629 of term life insurance. The calculations are as follows:
Life Insurance Calculator (Update)
I just found this nifty life insurance calculator that should help you determine how much term life insurance you need. It’s simple to use and I’ve already used it with a couple of clients.
When buying life insurance, be sure to shop around rates. I’ve seen life insurance companies differ greatly in their premium amounts. To give you a gauge of what to expect to pay, the $250,000 policy that I mentioned that I took out when I was 28 cost me around $220 a year. That’s it! A couple reasons that it was so cheap was:
- I was young (why does that seem so long ago?)
- I was (and still am) in good health.
Nonetheless, that’s a small price to pay to ensure that your family is taken care of after you’ve gone.
More Kids = More Life Insurance (Update)
As I mentioned at the beginning of the post, our second son was on the way and I was left wondering if I had bought enough term life insurance to cover my family. Now writing this post, we have welcomed our third son and once again, I’m left wondering if I have enough. Here’s what I’ve done to this point.
After returning from Iraq and losing the SGLI (military insurance), I purchased a 30 term life insurance policy with a face amount of $250,000 (mentioned above). When our first son arrived, I purchased a separate 30 year policy with a face amount of $500,000. In case you can’t add, that brings the sum total to $750,000.
Do You Really Need More Insurance?
To most people that seems like a lot of insurance – and it is. But the Rose household wasn’t done producing babies
Our second son soon arrived and I knew that I needed to up the insurance amount. At this point, I was done going through life insurance medical exams and was ready to really up the ante. This time I had decided that I buy another 30 year term policy, this time for a lump sum of $1,500,000. That’s a lot of zeros, huh? Trust me, it felt weird for me, too.
So now I have a total of $2,225,000 of term life insurance. Cha-ching.
My rationale. Somewhat going against the calculation above, I went for a more simpler approach. I thought to myself how much of an income would my wife need to take care of herself and the kids in case I wasn’t around. We decided that $100k would be adequate.
Secondly, I concluded that 5% was an attainable rate of return (or withdrawal rate) that she could get on the money if she invested it. Really simple math says that $2,225,000 x 5% will get her $112,500 a year. Should be more than enough to take care of mama and the kiddos.
Lastly, term life insurance is cheap! For that amount of coverage my premium is nothing compared to the financial benefit that my family will have if something happens to me.
Life insurance is a must. If you don’t have any yet, see how cheap it is by using the quote engine below. Or you can get a free life insurance quote here.