- If you have dependents who rely on your paycheck for their living expenses, you should consider getting life insurance.
- Many employers offer life insurance as an employee benefit, but the coverage you get may not be enough.
- There’s no one-size-fits-all formula to determine how much coverage you need—it will depend on factors like the number of dependents you have and their living expenses.
- Your future goals, savings and whether you have debt will also impact the amount of death benefit you’ll want.
It’s understandable if getting life insurance causes you some anxiety. After all, researching it means having to think about our own mortality—nobody’s idea of fun.
But if you have a spouse, children or other dependents who rely on your paycheck to fund their daily needs, it’s critical not only to have life insurance, but to do the math to make sure you have enough.
One of the most important choices that you’ll make when buying a life insurance policy is the death benefit amount, or the payout your beneficiary or beneficiaries will receive, tax-free, when you pass away. Your beneficiary is the person (or institution, in the case of a charitable gift) who will receive the death benefit amount if you die.
While many companies offer life insurance as an employee benefit, sometimes for free, the amount of coverage you get typically isn’t enough for most families (though many companies allow you to purchase more coverage for a fee). So even though 60% of civilian American workers had access to life insurance through their employer in 2021, you may find that you don’t have adequate coverage.
How do you figure out how much life insurance you need? Here are the things to consider.
Inside this article
How do you know if you really need life insurance?
Generally speaking, if you’re the only one who depends on your income to cover living expenses, you don’t really need life insurance.
“You’re better off saving and investing in your retirement fund,” says R.J. Weiss, a Certified Financial Planner and founder of The Ways to Wealth. “Down the road, you’ll then need less life insurance and can save money that way.”
However, if you have dependents, ask yourself what would happen if you passed away tomorrow. How would your loved ones make ends meet without your paycheck?
Maybe you want your family to be able to stay in their current home, so you’ll need a large enough life insurance benefit to cover future mortgage payments. Maybe you also want to fund all or most of your kids’ college tuition. You can factor that into your life insurance coverage.
There’s no magic formula for calculating the perfect amount of life insurance
One piece of conventional wisdom dictates that you should purchase a policy with a death benefit of 10 times your annual income. But it may not make sense to apply such a one-size-fits-all solution when people’s individual situations vary so much.
“The 10 times your salary rule of thumb is a starting point, but it does have its holes,” Weiss says. “For example, one of the primary factors in determining how much life insurance you should buy is the number of dependents you have and whether you wish to pay for each dependent's education cost.”
The 10 times rule doesn’t account for the number of dependents you have, which means that someone with four children would theoretically buy the same amount of life insurance as someone with only one child, Weiss points out. Obviously, expenses are going to increase as household size does, so you’ll want to take that into consideration.
5 factors to consider when choosing the amount of your death benefit
“When calculating the amount of life insurance to buy, you want to take into account both the needs of your family and the potential financial burdens your death could create,” Weiss says.
Here are the five main factors that Weiss says should guide how much life insurance you purchase.
How much debt you have. You’ll want enough insurance to pay off your non-mortgage debt and final expenses like funeral costs.
Your family’s current living expenses. Think about a payout amount that will cover mortgage payments, childcare costs and other everyday bills.
How much you already have in savings. If you already have substantial savings, you may not need as much life insurance.
Your future goals. “If you have specific financial goals for your family, such as sending your kids to college, you’ll want to make sure those are taken care of with your life insurance policy,” says Weiss.
Existing life insurance coverage. If you’re lucky enough to have some coverage through your employer, you don’t have to purchase as much coverage on a policy of your own.
To help put these expenses into context, Weiss recommends filling out several different online life insurance calculators (such as one from LifeHappens.org or Northwestern Mutual) to get an idea of how much coverage you might need.
“Some are more robust than others, so you’ll see a wide array of factors you might want to consider and settle on a number you’re comfortable with,” he says.
Once you land on a coverage amount that works for you, you’ll have to decide who the beneficiary or beneficiaries will be.
This is something people often fail to consider when buying life insurance, Weiss says.
“Should they list minor children? Set up a trust? Should 100% go to your spouse? Should it go equally to all your children? Should children have full access to the funds at 18?” he says. “There’s no definite answer here, but it’s something to think about, and often get expert advice on, when buying a policy.”
When you purchase life insurance, consider disability insurance as well
In some ways, life insurance and disability insurance have the same goal: to replace your income if you become unable to work, whether it’s due to illness or injury or due to death.
Although more people have life insurance than disability insurance—57% and 20% of eligible Americans, respectively—it’s more likely that you’ll need to use your disability insurance than your life insurance during your working years.
According to the Social Security Administration, the typical American born in the year 2001 has a 25% chance of becoming disabled during their working life before they reach retirement age. Their chance of dying during that period is significantly lower, at 14%.
Additionally, disability insurance isn’t just for people who have loved ones who depend on them financially—if you become disabled and can’t work, you’ll need to continue to support yourself somehow.
Life insurance and disability insurance can give you the peace of mind that comes with being sure that your loved ones who depend on you will be taken care of if something were to happen to you. A bit of thought, planning and calculation now can save your family a great deal of stress down the road if the worst happens, making an incredibly difficult time slightly less so.