For any American looking to purchase their first, or even subsequent, life insurance policy, choosing the right amount isn’t a black and white decision. There are many things to consider, especially when there are dependents, a business, or even an estate to properly plan for.
Life insurance death benefits can range from $5,000 up to virtually any amount, so long as a carrier or group of carriers are willing to offer it. Consumers can choose a nice, round number like $250,000, or a very specific amount like $813,767. In either case, the idea behind finding the right amount is to account for all possible obligations, and not a penny more, in order to pay the least amount of premium possible while still completely protecting yourself and family.
So, How Much Life Insurance Do I Need, Anyway?
With a pen and paper handy, the best way to get started is to begin making a list of all the people who depend on you, all the debts you owe, and a basic time frame for how long you might need each. Here are things to consider:
- Replacing your income to your dependents for a certain number of years
- Paying off debts, like mortgages, student loans, credit card bills or business loans
- Pre-paying for your children’s largest expenses, like college
- Donations for charities, organizations, churches and universities if you had plans to do so
- Taxes, like estate or inheritance taxes
- Burial or cremation costs, and possibly supplemental proceeds for medical bills
In listing just those, you’re likely to come up with a completely different number than your friends or family. Every person evaluates their plan in a different way, both based on need as well as what they want to provide should something happen.
Even if you’ve accurately compiled a list and a final number, you have more work to do.
Next, it’s time to factor in what you have currently which might lower your death benefit need. Some people don’t like to include these because they can change drastically, but items like current savings, IRAs and 401(k)s, pension or social security benefits (if not joint), and other valuables could go against the total you came up with.
Also, consider any insurance you have now. You may have a plan through work, a supplemental policy attached to a health insurance policy, or even private insurance you bought previously for another purpose. These can also lower the amount you need, so long as you can count on the fact they’ll be available as life changes are made, such as occupation changes.
If you weren’t certain about any of the items above, we’ll get more specific about each one so you can grasp what it is you need to replace, and what the actual dollar amount might be. Again, every situation is unique, so take your time in figuring your required death benefit to ensure the best possible care should your beneficiaries need to file a claim.
The largest item most people have to protect is their human capital. Human capital is basically how much you might earn throughout your lifetime, assuming a steady career over a normal working time period. For the younger folks, this might mean replacing a large number of years worth of income.
Individuals in their 20’s have the longest time period to replace, but obviously trying to guess retirement age and salary over that time period is unlikely to be accurate. Rather, the most common method is to multiply your current or expected income times a variable from 7-12 years on average. The best insurance companies will allow as much as 30x-40x income, but this is probably too much for the average person except for various reasons.
Even if you don’t work, there may still be actual monetary value to replace. Take a mother who home schools her children, for example. Even though she may not be receiving a paycheck, she provides real value to the household which the husband might have to pay for in order to continue his normal job should something happen to her. Life altering changes would otherwise be required in order to account for the new responsibilities which would reduce his own income.
Most Americans carry some sort of debt. Whether it be student loans, credit cards or mortgages, there’s a good chance you owe someone something, and in the case of death, these debts can burden your dependents, spouse, or business. The key is to provide enough immediate cash for either payments or complete liquidation of all transferable loan types.
Not all debts will transfer to someone else, but anything co-signed, shared debts between spouses, or outstanding business-type loans are all usually considered someone else’s responsibility when the primary lessee passes before the obligation matures. If there’s any doubt, call the lender to verify how it would be treated if an untimely death were to occur.
Rarely chosen, but still an option, having additional death benefit designated to pay for your children’s college expenses is allowed. Even if you are unsure your children will attend additional education beyond high school, it could be considered a gift to them to use either as they please or per your suggestion.
Just be careful how you allocate any proceeds which could go to a minor. Even if the intentions are great, simply naming them without any contingencies in a will or trust, especially without naming someone as guardian to the assets, can complicate the situation for both the responsible party to the minor and the minor themselves.
Charitable donations and contributions can also be made from the payout of a life insurance policy. This is a great way to not only leverage current money into future cash, but there are tax advantages of doing so for both you (or your estate) and the recipient of the funds.
Churches, fraternal organizations, universities, charities and other non-profits are most common. As with minors, you can stipulate exactly how the funds are used, for what cause, and what the end goal of the funds are.
While some policies are strictly for burial, larger term policies need to add in proper amounts of funds in order to pay what are considered final needs. Final needs are costs for burial, but also unexpected costs like medical bills, travel or arrangement fees. While burial policies range from $5,000 to $25,000, any amount could be allocated here, within reason, depending on what type of funeral or cremation you intend to have. having life insurance set aside for this purpose is the cheapest way to pay, as opposed to paying from savings, buying prepaid packages from a funeral home, or other methods of prepayment.
While most citizens don’t need to worry too much about this area, those who have larger estates need to plan meticulously for estate taxes and inheritance taxes if possible.
Planning for an estate is a very involved process, usually requiring both an estate tax lawyer and accounting professional. The letter of the law needs to be correct, especially when life insurance policies or their proceeds are held inside of irrevocable trusts. Estates which are passing down other types of assets, like real estate, business ownership, or other non-cash like items can complicate matters as well. In most cases, it might be better to consider estate planning with a separate life insurance policy altogether.
How Much Is Enough?
Just enough. Never buy more than you need, except if it might allow you to take advantage of a price break. If you need $490,000 in coverage, buying a policy at $500,000 would actually be cheaper due to breaks in the pricing models for most companies. This goes the same for choosing how long to lock in your rates, as well. A 10-year obligation doesn’t need any more than a 10-year policy to save maximum premium dollars.