How Much Life Insurance Do You Need?

You have probably encountered the simplistic heuristics designed to help you estimate your life insurance needs. Perhaps the most common such rule of thumb is to multiply your salary by a certain number, typically 8-10. While these formulas can provide a very rough estimate, they are otherwise unreliable due to their failure to account for individual differences, which exist even among people with identical incomes. The size of your death benefit will depend just as much on your familial and financial situation as it does your salary. The needs and composition of your family, your assets, and your debts are all variables that affect how much coverage you need. Read on to learn how to include all of the aforementioned variables in your estimation of your coverage needs.

The Shortcomings of the Salary Multiple Method

Before we explain how to compute your ideal death benefit, it's important to understand why simply multiplying your salary by a certain figure is a poor approach to financial planning. For example, say two men earn exactly the same salary. Using the multiplier method, these two men would seem to need to same amount of coverage. However, one of the men has three young children, a stay-at-home spouse, and a mortgage, whereas the other man is nearing retirement, has no children, and owns his own home. Clearly, these two individuals would have vastly different death benefits due to their disparate circumstances.

Costs to Consider in Estimating Your Death Benefit

Using an online calculator is one way to arrive at a reliable approximation of your requisite death benefit. A good calculator will account for all the most influential variables and saves you the trouble of figuring things out by hand. However, online insurance calculators may also offer too much of a one-size-fits-all estimation of your needs. For instance, if you have a child with a disability who will never be self-supporting, you would need more coverage but the calculator would likely not account for that.

If you would like to estimate the death benefit you should purchase without an online calculator, here are the factors and costs you should consider in doing so:

Burial expenses. According to the National Funerals Directors Association, the average funeral costs between $7,000-$10,000. Flowers, coffins and/or cremation, probate costs, and other expenses quickly add up.
Your income. If you were to die now, how many years would your dependents need your income to make ends meet? Whatever that number is, multiply it by your annual salary.
Education costs. Do you have children who will attend college? Estimate how much you want to contribute total to each child's college education.
Ages of children. The younger your children are, the larger your death benefit needs to be.
One-time expenses. Think about future expenses that you would want your policy to cover in the event of your death, such as weddings, new cars, home renovations, etc.
Investments. If you have substantial investments available, you can typically subtract their value from your coverage estimate.