So… How Much Life Insurance Do You Need?
At the very least, a life insurance policy should have enough coverage to pay for your funeral expenses. According to the National Funeral Directors Association, the average cost of a standard funeral with a viewing and burial was around $8,000 in 2021. Similarly, a funeral with a viewing and cremation rather than burial was slightly less at $7,000. While these costs will vary a bit depending on where you live, you can expect with inflation to pay close to $10,000 over the next few years, even with the less expensive options.
The amount of life insurance you should have varies based on how much your family depends on your income assistance, what debt you and your family have, the funeral costs mentioned above, and any additional financial needs your family may have without you.
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Life, Death, and Financial Obligations
Your financial obligations do not suddenly disappear upon your death. Instead, they become your estate’s responsibility, and your family could also be liable for your outstanding debt if they cosigned or co-owned a loan with you.
Besides potentially shouldering your unpaid bills after your passing, your loved ones may also have to bear the burden of end-of-life expenses such as funeral, burial, and hospice care costs. In 2021, it’s estimated that the average surviving family member in the U.S. spends $7,848 on funerals with viewing and burial. That’s not including other end-of-life expenses like hospice care, which can often be upwards of $10,000 a month. These expenses can quickly add up and put more pressure on your loved ones struggling with grief.
So, while there are many different types of life insurance products on the market, the primary purpose of life insurance is to ensure your loved ones are financially taken care of after your passing and that they do not become burdened by debt.
Life, Death, and Financial Obligations
Your financial obligations do not suddenly disappear upon your death. Instead, they become your estate’s responsibility, and your family could also be liable for your outstanding debt if they cosigned or co-owned a loan with you.
Besides potentially shouldering your unpaid bills after your passing, your loved ones may also have to bear the burden of end-of-life expenses such as funeral, burial, and hospice care costs. In 2021, it’s estimated that the average surviving family member in the U.S. spends $7,848 on funerals with viewing and burial. That’s not including other end-of-life expenses like hospice care, which can often be upwards of $10,000 a month. These expenses can quickly add up and put more pressure on your loved ones struggling with grief.
So, while there are many different types of life insurance products on the market, the primary purpose of life insurance is to ensure your loved ones are financially taken care of after your passing and that they do not become burdened by debt.
How Does Determining Life Insurance Amounts Work?
You should purchase enough life insurance to cover your obligations after you’re gone. While it may be challenging to pinpoint the exact amount of coverage you need, you could make a reasonable estimate by taking into factors such as your income and your household’s financial needs.
Who Should Consider Life Insurance?
Before determining how much the value of your life insurance should be, consider whether you need it at all. If any of the following applies to you, investing in a life insurance policy could be beneficial:
- If your partner, children, elderly parents, or other dependents live off your income.
- If you contribute to your family’s mortgage or college expenses.
- If your family does not have the budget to pay for your end-of-life expenses out of pocket.
- If you have debt that could be passed on to your loved ones, such as a mortgage or an unrepaid loan.
- If you have business partners who might fail without you.
- If you have employees who rely on you for their paychecks.
Coverage Estimator
Income Replacement
Using income replacement to determine your life insurance coverage amount assumes you are still working and providing financial benefits to your family. Should you die unexpectedly and your family depends on your income, you want to ensure that your life insurance will give them income for as long as they need it
For example, if you are 40 years old and expect to live until 75, you want to times your annual income by 35 years. The number you come up with would be considered your income replacement for your family. Don’t forget to add extra to account for inflation. An easy way is to add another year of your salary to the death benefit.
Mortgage, Car Loan, and Other Debts
One way to ensure your family is taken care of financially if you die is to have enough life insurance to pay off your debts. Life insurance is there to ease the financial burden off your family. If they can pay off the mortgage, auto loans, credit cards, or any other debt your family has, they will be able to breathe much easier without losing your expected income.
Burial Costs
While funeral and burial, or cremation, costs may not inflate as much as everything else, they rise over the years. With the expected costs being close to $10,000, you should have this much in life insurance coverage at a minimum.
Financial Needs For Your Dependents
While your dependents’ financial needs already include your income, there could be other expenses you should take into account. If you have children who may eventually go to college, you should consider tuition costs and plan for this financial burden should you die unexpectedly. If any of your dependents have a disability and need ongoing medical care, you should calculate these expenses into your life insurance coverage amount.
You may have young children that attend daycare, or if your spouse stays at home, they may need to go back to work if you die, causing a need for childcare expenses. Try to consider any possible dependent care expenses that could pop up without your income.
Liquid Assets
You can reduce the amount of life insurance you need if you have any liquid assets. A liquid asset is anything you own that could be sold for your family to have the cash. Liquid assets can include money market investments, savings or cash on hand, stocks and bonds, mutual funds, or even investment properties. Since your family would have access to the liquid assets and the ability to turn them into cash, you can subtract this amount from your life insurance calculation when purchasing your policy.
Should the Type of Insurance Affect the Value of the Policy?
How much coverage you need should depend on your and your loved ones’ financial needs and not the type of insurance you choose.
While permanent life insurance typically offers a cash value component, you’re only allowed to use it while you’re alive, and any unused amount generally reverts to the insurance company. In other words, your beneficiaries will only receive the death benefit amount, not the cash value component. So, if you want your loved ones to receive a certain payout when you pass, your policy’s value should not be affected by whether you choose term life insurance or permanent life insurance with an investment feature.
If you want the least amount of life insurance possible while keeping your family financially protected, consider term life insurance. Some insurance providers offer coverage amounts starting as low as $25,000.
What Are the Components of a Life Insurance Payout?
The death benefit amount is the primary component of a life insurance payout, and it’s the money your beneficiaries receive when you die. On the other hand, the cash value component is the savings/investment account you can borrow against or withdraw from while you’re still alive. Note that only you can access the cash value component, and your beneficiaries will not receive any funds from it upon your passing. All life insurance policies have a death benefit, but only permanent life insurance offers cash value.
What to Consider When Using Life Insurance As An Investment Tool
Besides providing your loved ones financial relief when you pass, permanent life insurance featuring a cash value component could also serve as an investment tool that can provide supplemental income in your golden years. However, it’s important to note that permanent life insurance typically features notably more expensive premiums since it covers your entire lifetime. For example, one insurer’s 20-year term life insurance only costs $24 a month for a healthy 35-year-old female, while their whole life insurance comes with a much heftier price tag of $477 a month.
While permanent life insurance is generally more expensive than term life insurance, it may make financial sense if you have lifelong dependents, want to help your heirs cover estate taxes and funeral costs upon your death, or are looking for a way to supplement your retirement income.
Whole, Universal, and Variable Coverage
Permanent life insurance comes in three main types: Whole, Universal, and Variable.
- Whole life insurance: Whole life insurance offers lifetime coverage with a cash value component, an investment feature that earns interest and grows tax-deferred. However, this type of permanent life insurance typically does not allow you to adjust your death benefit as your needs change.
- Universal life insurance: Unlike other policy types, universal life insurance provides much more flexibility, allowing you to modify your life insurance premiums, cash value component, and death benefits depending on your needs.
- Variable life insurance: One significant difference between variable life and other permanent life insurance policies is the level of investment risk involved in the cash value component. While variable life insurance allows policyholders to invest their cash value in stocks, mutual funds, or other financial commodities, the return on investment is not guaranteed. So while it offers greater growth potential, it’s also riskier.
Suppose you’re looking to get minimum permanent life insurance coverage. In that case, you may want to consider universal life insurance, as it allows you to adjust your monthly premiums and coverage amount if your needs change in the future. Still, it’s worth speaking with a life insurance agent before deciding.
Cash Value
If you have other retirement investment options and want to add a little more to the mix, life insurance that accrues cash value is excellent. The cash value is accrued tax-deferred, and if you die without utilizing it, your beneficiary will receive it in addition to the face value on the policy.
Dividends/Loans/Withdraw
Some life insurance companies will pay dividends to those who invest. You can take this cash and save it or reinvest it back into your policy. You can also take out a loan against your policy while still living, interest-free. Keep in mind that if you do not pay it back and die, the balance will reduce your death benefit. You can also withdraw any cash value that has accrued with no tax implications.
What If You Want To Change the Value of Your Life Insurance?
Some insurers allow you to modify the value of your life insurance by increasing or decreasing it. However, they may restrict the times you can change the coverage amount within a specific timeframe. Contact your insurer to see if you’re eligible to tweak your coverage.
If you think you’ll need to adjust the value of your life insurance often, consider looking into universal life insurance (also known as adjustable life insurance) since it allows you to modify your coverage amount and monthly premium payments as your circumstances change.
How To Select the Value of Your Life Insurance
There’s no one-size-fits-all coverage amount for life insurance, as how much you need is often determined by factors unique to your circumstances. Here’s how to select a coverage amount that suits your situation best.
1. Assess Your Current Financial Situation
Before shopping for life insurance, evaluate your financial situation, such as your income, debt, and monthly disposable income, so you have a realistic idea of how much you can spend on life insurance premiums. Doing so lets you find a policy that suits your lifestyle needs and would not strain your budget. Note that permanent life insurance typically costs multiple times more than term life insurance, so consider looking into term life insurance first if you’re on a tight budget.
2. Assess Your Family’s Future Financial Situation
Once you know your budget, consider your household’s financial needs. For example, if you need life insurance to cover your income until your children finish college, a 20-year term life insurance policy may be suitable. In this case, you should purchase enough coverage to help your beneficiaries replace your income and pay for your children’s tuition.
On the other hand, if you’re looking to supplement your retirement income and leave an inheritance for your loved ones, a permanent life insurance policy with a cash value component may be a better option. Consider working with a financial planner to discuss the coverage you need.
3. Shop For Plans
Next, it’s time to shop for life insurance plans. Most insurers allow you to request free quotes online by answering a few simple questions about yourself. You could also work with an independent life insurance agent to help you find an affordable plan that fits your needs. Before choosing a life insurance policy, perform your due diligence and ensure the insurance company has strong financial ratings from independent rating agencies such as A.M. Best and Standard & Poor.
4. Review and Reassess Periodically
Your life insurance needs may change as you age. After purchasing a life insurance policy, remember to review and reassess it every few years to ensure it stays up to date. Doing so is especially important if you experience significant life changes such as a divorce, the loss of a family member, or having children. Contact your life insurance company for detailed instructions on making changes like adding more coverage or removing beneficiaries.
And if you believe you’ll need to make frequent adjustments to your life insurance plan, consider looking into adjustable life insurance policies. They’re a hybrid of term and whole life insurance, allowing you to adjust policy features, such as face amount and premiums.
Putting It All Together
Determining the right amount of life insurance is a critical financial decision that requires careful consideration of your unique circumstances. It’s not a one-size-fits-all equation, but rather a thoughtful assessment of your financial responsibilities, future goals, and the well-being of your loved ones.
To find the ideal coverage, consult with a financial advisor, consider your debts, income, and expenses, and revisit your policy regularly to ensure it remains aligned with your evolving needs. Remember, life insurance isn’t just about providing financial security; it’s a powerful tool for peace of mind, ensuring your loved ones are protected no matter what life may bring.