Life Insurance

How Much Life Insurance Do You Need?

Determining how much life insurance you need can be simple, but there are many factors to consider.

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Every person should consider having life insurance, whether it may be a small policy for funeral expenses or a more significant policy to pay off debt. How many dependents you have, the amount of debt you have, and some other factors will influence how much life insurance you need.

The Minimum Life Insurance Coverage Needed

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. 

How to Calculate How Much Life Insurance You Should Have 

You may have heard of a few ways to calculate how much life insurance you need. A standard and quick method that many people tend to go by is 10 times your annual income. So, if your annual income is $100,000, you would have a life insurance policy with a death benefit of $1,000,000. Some experts say to add extra on top of that amount for each child, so they have money for college expenses.

The DIME method is another way to calculate how much life insurance you should have. DIME stands for debt, income, mortgage, and education. To complete this method, you would first add up your debt like credit cards, auto loans, and funeral expenses. Next, estimate how many years your family may need your financial support and multiply that by your annual income. 

Last, add up any amount you need for your children’s college expenses and your remaining mortgage. Once you have all 4 of these numbers, you can add them all together, and this gives you the DIME method of calculating your death benefit needed. 

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.

Using Your Life Insurance to Invest For Retirement 

Life insurance does not always have to be about planning for death. Life insurance can also be used as an investment tool for your retirement portfolio. There are a few benefits to using life insurance as an investment.

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.

Reducing Your Coverage If You Have Other Savings 

Some of the things to consider when calculating how much life insurance you need may not apply to you if you already have funds set aside. Many people start a college fund for their children when they are young. If you have a college fund already set aside, you don’t have to add that into your life insurance calculations.

Some people even have savings allocated for funeral costs or have prepaid their burial or memorial expenses. If you have already paid for your funeral expenses, you can reduce the life insurance you need.