How much?

How much life insurance coverage I need to buy was something that really wasn’t important to me until I got married.

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 Table

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.

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.

Life Insurance Example

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 Needed

Shop Around

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:

1. I was young (why does that seem so long ago?)
2. 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 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.

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.

photo credit: karmablue

What type of life insurance should you buy

You are likely to need some type of life insurance if others depend on you for financial support, if you provide your family with such services as child care, if you need to consider protecting a surviving spouse or if you have accumulated substantial assets.  When I was single, life insurance was not a priority of mine.  It was not until I got married that I bought my first term life insurance policy.  I thought the amount was fine until we had our first child.  At that time, I almost doubled the amount of life insurance that I had.  It might be the extreme, but I want to make sure my family is taken care of in the event something were to happen.

There are several types of life insurance that you may need and want to consider.  For any younger age individual, term life insurance is the way to go.   There are some cases where the others “may” make sense, but in almost every occurrence I’ve came across somebody having them, they were sold to the person and not the type of life insurance they needed.

Types of Life Insurance

• Term insurance is the most basic, and generally least expensive, form of life insurance for people under age 50. A term policy is written for a specific period of time, typically between one and 10 years, and may be renewable at the end of each term. Premiums increase at the end of each term and can become prohibitively expensive for older individuals. A level term policy locks in the annual premium for periods up to 30 years.

• Whole life combines payment protection with a savings component. As long as you continue to pay the premiums, you are able to lock in coverage at a level premium rate. Part of that premium accrues as cash value. As the policy gains value, you may be able to borrow up to 90% of your policy’s cash value tax-free.

• Universal life is similar to whole life with the added benefit of potentially higher earnings on the savings component. Universal life policies are also highly flexible in regard to premiums and face value. Premiums can be increased, decreased or deferred, and cash values can be withdrawn. You may also have the option to change face values. Universal life policies typically offer a guaranteed return on cash value, usually at least 4%. You’ll receive an annual statement that details cash value, total protection, earnings, and fees. Drawbacks include higher fees and interest rate sensitivity — your premiums may increase when interest rates rise.

• Variable life generally offers fixed premiums and control over your policy’s cash value, which is invested in your choice of stocks, bond, or mutual fund options. Cash values and death benefits can rise and fall based on the performance of your investment choices. Although death benefits usually have a floor, there is no guarantee on cash values. Fees for these policies may be higher than for universal life, and investment options can be volatile. On the plus side, capital gains and other investment earnings accrue tax deferred as long as the funds remain invested in the insurance contract.  Meeting with a financial advisor will determine if variable life insurance is best for you.

How Much Insurance Do I Need?

Figuring out how much life insurance you need is the next step.  A popular approach to buying insurance is based on income replacement. In this approach, a formula of between five and 10 times your annual salary is often used to calculate how much coverage you need. Another approach is to purchase insurance based on your individual needs and preferences. In this instance, the first step is to determine how much income you need to replace.

Start by determining your net earnings after taxes (insurance benefits are generally income tax free). Then add up your personal expenses (food, clothing, transportation, etc.) This will provide an idea of the annual income that your insurance will need to replace. You’ll want a death benefit which, when invested, will provide income annually to cover this amount. Remember to add amounts needed to fund one-time expenses such as college tuition or paying down your mortgage.

Buy The Right Type of Life Insurance

Purchasing the right type of life insurance in an amount that is suitable for your family’s needs is an important element in financial planning. You may want to consult a Certified Financial Planner (I might have a good one in mind) who can help you implement the details.

photo by merriewells

*Variable insurance guarantees are based on claims paying ability of the issuer.  Withdrawals made may be subject to fees when distributed and treated as ordinary income.   Outstanding policy loans at death, and withdrawals, will reduce the policy death benefits and cash values.  The investment returns and principal value of the available sub-account portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than their original value.