How Much Life Insurance Do You Need?

If you’re anything like me, you probably don’t give life insurance that much thought.  The question is: how much life insurance do you need?

This article will help you decide if you need life insurance, what type of life insurance you may need, and answer the question of how much life insurance you really need.

With all of the life insurance options out there, it can be pretty difficult for the normal person to determine how much life insurance you need.

Don’t be like Donny and end up in a Ralph’s Folgers coffee can (I couldn’t resist the Big Lebowski reference).  Read on for everything you wanted to know about life insurance but were afraid to ask!!

Do You Even Need Life Insurance?

You may be surprised to hear that many folks don’t really have a need for life insurance!  If you aren’t married or don’t have any dependents, then there is really not much need for life insurance.

Life insurance is there to help your dependents make ends meet when you pass away.  If you don’t have any dependents, there is no real need for life insurance other than to cover your own funeral expenses.  You wouldn’t want to stick Mom and/or Dad with the bill now would you?

Assuming you have dependents (or you’d like to get a small amount of life insurance to cover your funeral expenses) let’s move on to talk about the different types of life insurance.

 

What Type of Life Insurance is Right For You?

There are four main types of life insurance that you’ll need to consider when deciding what type of life insurance is right for you.  I’m sure there are many more creative variations on these, but the four basic types boil down to:

1. Term Life Insurance
2. Universal Life Insurance
3. Variable Universal Life Insurance
4. Whole Life Insurance

Here a quick table I threw together to illustrate the important features of each type of life insurance.

	Term	Universal	Variable Universal	Whole
Cost	$	$$	$$	$$$
Specific Coverage Period	X
Cash Value Component (earns interest)		X	X	X
Can temporarily stop making payments (emergency)		X	X	X
Can take a loan against policy		X	X	X
Can decide investment direction of cash component			X
Premium fixed				X
Death benefit fixed	X			X
Flexibility	++++	++	+++	+

 

For most ordinary folks, term life insurance is the easiest and best way to go.  It is the cheapest form of life insurance, offers the most flexibility, and is the easiest to understand.  I’d venture to guess that 90+% of folks would fall into this category, although consumers can research and compare term vs permanent life insurance to find the right type for their specific needs.

Universal life insurance can be a plus if you personally have a hard time saving money.  This is because universal life insurance has a built in cash value component.  This means that a certain portion of each monthly premium goes into a cash account that earns a set amount of interest.  This interest is usually less than the market average, so it really isn’t for folks that are adept at saving money without “help”.  This type of life insurance is more expensive than term life insurance.

Variable Universal life insurance is very similar to vanilla universal insurance except it lets you determine how you’d like to invest the cast component of your premium payments.  This give the potential for better returns, but adds an element of risk in that your cash component could lose value.  Again, I don’t see the point if your skilled at saving and investing your own money.  This type of life insurance is more expensive than term life insurance and generally a little more expensive than just vanilla universal life insurance.

Whole life insurance is the most expensive type of life insurance, but can be important in certain situations.  In these cases, you’ll pay a fixed premium for your entire life and you’ll know exactly how much you’ll get when you croak.  I’ve heard that this can be a viable option for folks that have known health issues, but I haven’t done in-depth research into it.  This type of insurance is the least flexible, as once you sign on the dotted line the policy is set in stone.

Now that you’ve selected the type of life insurance to get (most likely term life insurance), let’s answer the question – how much life insurance do you need?

 

How Much Life Insurance Do You Need?

So, how much life insurance do you need?  We can answer this question by looking at a couple different aspects of your current life and the plan you have for your dependents after you pass away.  After you’ve considered each of these questions, it’s simple math to arrive at the final total life insurance coverage that you’ll need.

Things to consider:

1. How much do you need for funeral costs (the current average is ~$7,300 for a funeral) 
2. How much debt do you have that you’d like to cover with your policy (house, car(s), credit cards, etc.)?
3. If your spouse is currently not working, will you assume they’ll go back to work?
4. If you’re a US citizen, what amount of what amount of Social Security benefit will your family receive if you die?
   1. Click the link above, read short description.
   2. Click calculator to determine your benefit.
   3. Basically, your spouse and each kid get 75% of your benefit each up to a family maximum of 180% of your benefit.
   4. To find your benefit, assume you retire now (die) at your current age.
5. Considering your answers to questions #2, #3, and #4, what annual expenses will the policy need to cover?
6. How many years of expenses will need to be replaced?
7. Should your policy include money for any kid’s college tuition?  If so, how much total?
8. What amount of savings, retirement savings, college savings, etc. do you already have?
9. Do you need a lump sum payment to keep a family business running in the short term

Other topics to consider:

• Will you assume that your spouse will re-marry at some point?
• When will your spouse plan to retire?
• After you pass away, do you want your family to be: “living on easy street”, largely the same as before, or “on their own” to come up with a new life style in a couple of years?

Other Life Insurance Tips

Here are some other life insurance tips/facts that you may find useful that I ran across while conducting my research:

• Each year that goes by the typical person will need less and less life insurance.  This is because theoretically: you’ve saved more, your debts (home, student loans, etc.) are decreasing, your spouse is one year closer to retirement/social security, and your kids are one year closer to being on their own.
• Life insurance is really to protect against catastrophic loss for your family.  This means it will help them from getting thrown out on the street if you die.
• If you’re a US citizen, Social Security kicks in for your spouse (if caring for children under 16), and your kids (if under 18) up to a family maximum.  Read more about it here on the Social Security Administration’s website and try their calculator here.  For my family, this would run ~$1,500 a month if I die tomorrow.
• The minimum insurance I’d recommend would be to pay off funeral expenses and eliminate all debt for your family.  If you’re on your own, your debt will disappear at your demise – so, you’ll really only be interested in funeral expenses.
• One quick way to calculate how much coverage you need – funeral costs plus 5-years TAKE HOME PAY (this actually works pretty well and matches up with my more detailed analysis you’ll see in a future post).
• Assume $10,000 for burial expenses just to be on the safe side.
• This is to protect your family, not make everyone wealthy and lazy.
• Funny quote: Get enough life insurance to keep your wife and kids from getting thrown out into the streets, but not so much that her next husband is having a party.
• A life insurance disbursement will pass to your spouse tax free.
• There is really no need for life insurance on children.  You are not dependent on them.  You’re better off having savings/investments that could cover a funeral if that unfortunate event were to happen.

 

Final Thoughts

There you have it.  This should be a good guide to help you get started on assessing if you need life insurance, the right type to select for yourself, and how much life insurance coverage you’ll need.

Stay tuned for my next post where I’ll go into details (using the questions above) to see if I’m over-insured.  If so, we’ll look at how much I’m losing each year by paying for unnecessary insurance.  There could be a money saver there!!!