Calculating the right amount of life insurance takes a lot of research and can be quite a balancing act. You want to ensure you have enough life insurance to protect your family if something happens to you adequately. On the other hand, if you buy too much life insurance, you’ll feel financially strained-which means you’ll be more likely to cancel your policy in a crunch.
The goal is to have enough life insurance to safeguard your family without breaking your budget. If you’re trying to figure out how much life insurance you need, here are a few things to keep in mind:
Find the right policy
There are two basic types of insurance policies: term insurance and cash-value insurance. Term life insurance covers you for a specified amount of time, anywhere from one to 30 years. These policies are less expensive because they are designed solely for protection. Many people choose term insurance because they figure their need for life insurance will decrease as they get older. Term insurance is also a good option for those who want to protect their children until a certain age.
Cash-value life insurance covers your entire life and includes whole life, universal life, and variable life policies. These policies act as both an insurance plan and a savings tool, which makes them more expensive. Because the insurance company actually invests some of your premium, this type of policy increases in value over time. You can borrow money from the policy, although outstanding loans will be subtracted from the ultimate death benefit. In most cases, the premiums and death benefit remain the same throughout the life of cash-value policies.
Figuring the right amount
There are a few different ways to calculate the life insurance you need to protect your family adequately. Some experts say you should multiply your annual income by three times, while others say you need at least eight times your annual salary.
However, many professionals say this “income multiplication” method is inaccurate. Because each family faces a unique set of circumstances and needs, you may want to consider some factors other than annual income. Figuring out the right amount of life insurance requires a comprehensive evaluation of your financial goals, debts, investments, lifestyle, and habits.
Expenses to consider
As you determine how much life insurance you need, you should consider the expenses your family would face if something happened to you. Start by listing short-term expenses, such as medical and hospital expenses, funeral arrangements, attorney fees, outstanding debts, taxes, and loans. Then, add that amount to all your family’s long-term expenses, such as your home mortgage, college tuition for your children, and living expenses.
You should also factor in other sources of income, such as your spouse’s salary, Social Security survivor’s benefits, and investments. And don’t forget to consider the cost of inflation. Once you consider all of these expenses and sources of income, you’ll probably arrive at a much more realistic amount than simply “four times your income.”
What can you afford?
Although you may know how much life insurance you’d like to offer your family, you must be realistic about how much you can afford. The primary objective of life insurance is to protect your family. Therefore, you should choose a policy that you can comfortably fit into your budget so you won’t be tempted to cancel it.
Research shows that half of all people who buy a whole-life policy end up canceling it within the first ten years, likely because these policies are expensive, and it can be challenging to keep up with the premium payments. Because term insurance is relatively inexpensive and easy to understand, it may be the perfect solution for families on a budget.
Figuring out how much and what type of life insurance you need is a complex process involving much research and thought. You should meet with a financial advisor or insurance expert who can help determine how much insurance you need and what you can realistically afford.