Discretion is something you need to make use of while finding an answer to: how much life insurance do I need? Many people simply choose a lump sum of money without thinking of how much life insurance they actually need. They do neither calculations nor do they do any research. As a result, they either over-insure or under-insure themselves.
Consequently, while assuming a lump sum of money might not be the worst decision, it could not be the best decision either.
So, you had better start by asking yourself: how much life insurance do I need?
We suggest that you do some math before you calculate your life insurance need so that you may find the right coverage. Though there could be no exact-match figure for your life insurance need, this discussion will help you get a better coverage and best ensure the interest of your dependents.
Why to Avoid Over-insurance or Under-insurance?
Over-insurance is buying bigger life insurance coverage than what you would need.
What it means is…
You have an extra load on your monthly budget.
Instead of sending more of your money to saving , you put it into insurance.
Your dependents are deprived of things when you spend more on your life insurance.
And…
You know life insurance is often a useless investment!
Useless because only an estimated 7% to 8% of the term life beneficiaries find it useful. The rest are fortunate in that the policyholders survive their policies.
So…
In order for you to avoid over-paying for your life insurance, you had better avoid the ‘a lump sum’ trend.
On the other hand …
Under-insurance is purchasing less coverage than you would have the need to.
If you choose less than you should have, life of your dependents could be affected. They would have less financial resources than they would need if you could not be physically there to support them.
This means…
Your children may find it difficult to get proper education.
The life-style of your dependents might go sub-standard.
Also, they might have burdens that you might leave behind on their shoulders to pay off.
So…
Finding the right coverage for avoiding over-insurance as well as under-insurance is important.
How to Avoid Over or Under-insurance
Surely, you know the following three things about life insurance:
You do not need life insurance.
It is your dependents who need it.
You buy it so that they may have financial resources to live off well behind you.
So…
While fixing your life insurance coverage, you must make sure that you have cautiously sought out the answer to your question.
That is why, it is important to make sure that you take an all-out approach for finding the right life insurance need.
In order for that you should take all your present liabilities and the future financial needs of the dependents into consideration.
However, if you are not financially quite savvy, taking the all-out approach can be not-so-easy.
Good news is…
For you, there are different formulas to help you hit it right. They go a long way in finding an answer to your question—how much life insurance do I need, actually ?
The Formulas
The Salary Formula
This is the simplest of all the approaches that help you get to know how much life insurance you need. You multiply your annual salary by several times and there you are. However, the advocates of this formula cannot agree as to how many times you should multiply the salary by. While most speak for 10, others opine that it should be 5, 7 times your annual salary. Some even speak for 20 times.
Our Analysis of This Formula
Your financial and family backgrounds are important factors that should receive emphasis while determining your life insurance coverage. Important questions like whether your spouse is employed or you have loans or mortgages find no consideration in this approach. It is not impossible that your 10 years total salary may go to paying your mortgage loans. Also, very essential questions like the number of your kids, their present age and occupation etc. have no place in this formula.
Perhaps this formula for life insurance coverage is focuses on income replacement only. But the issue of inflation not being there makes this formula a weak proposition.
Modified Annual Income Formula
To find out the right amount of life insurance coverage you multiply your annual salaries by 10 first. Then you add $100,000 for each of your kids and the sum total answers to your question: how much life insurance do I need?
Our Analysis of the Modified Income Formula
While this formula tries to compensate for the limitation of the original formula, it also falls short of being an ideal approach. It does not take your financial liabilities into consideration. Nor does it consider the issue of inflation. It fails to view your personal situation like its mother formula.
Human Life Value Formula
This formula asks you to take into account all your expected income for the rest of your life ahead. Then you deduct all your personal expenses and taxes from the grand total. From this you get the amount known as the human life value. This is the coverage amount for your life insurance.
Our Analysis of the Formula
This approach to life insurance coverage is better compared to the above ones. It takes into consideration your potential income which your family members are expected to receive. However, this formula does not take possible promotions, changes in professions and investments into consideration.
Percentage of Income Formula
This formula suggests that you keep off 6℅ of your income for your life insurance. You should add another 1℅ of your income for each of your dependents. This is how you have your life insurance coverage.
Our Analysis of This Formula
This sounds to be an idealistic approach to life insurance coverage. Specific needs and priorities are not given importance in it. Because every individual’s situation is different, an idealistic approach may not meet everyone’s needs.
Coverage by Age Formula
You decide how much life insurance you need according as what age group you belong to. For example, the proponents of this formula suggest that if you are under your 30s, you should get life insurance coverage 25 times your annual income.
Our Analysis of This Formula
This again seems to be an idealistic approach to life insurance coverage. Your life situation is not taken care of.
The DIME Formula
DIME stands for debt, income, mortgage and education. According to this formula, these are the areas you need to focus on while finding your life insurance need. You add the sum total of your debt, mortgage and the probable educational costs of your children and add your 10 years yearly income to it to get the insurance coverage you need.
Our Analysis of This Formula
DIME is a more practical approach to life insurance. It takes into consideration the most important financial factors of your life. But on a sad note, the question of inflation has no place here.
Needs Approach Formula
This method has the widest possible areas of your financial priorities in determining your life insurance coverage. The areas that you focus on are:
Income tax, estate tax, gift tax, probate fees, legal fees, emergency funds, medical deductibles, rents, debts and loans, mortgage, childcare, legal fees, educational expenses of children, maintenance costs, burial costs etc.
Our Analysis of This Formula
As the Needs Approach encompasses all your life’s probable expenses into consideration it appears to be a more pragmatic approach toward your coverage determination. But the fact that it over-emphasizes your life insurance needs weakens this formula. It raises the coverage too high for the consumers to buy.
Which One Is the Best Formula?
We think every formula has their weaknesses and strengths. While some are too minimalist, some others are rather too maximalist in nature. We, Life Insurance Mentors team think that a better approach for deciding how much life insurance you need is to make a mix up of the formulas above.
Our Formula: DEMIS
This is how we throw DEMIIS for you to find your right coverage. This approach is a combination of various formulas that you already know about.
Take D of DIME and calculate your debts.
Now calculate the probable educational expenses of your children. We suggest that you follow the modified income formula for this. That is 100,000 dollars for each of your children.
Follow DIME’s M and add your mortgage (or any other) loan amount to your need.
Calculate 1% of your income to set off inflation. So, take I from percentage of income formula. (We changed it a bit.)
And finally, take S of Salary formula. Multiply your annual salary by 10 for the purpose.
What Are Ways to Find Life Insurance Need?
These days, getting to know how much life insurance you should buy has been easier than never before. You can decide your life insurance need free of cost and instantly from two types of online services. There are wealth management tools that you can take help of to determine you need.
Or, you can visit any of the life insurance company sites, do some calculations by yourself and put in the data to get the right life insurance coverage for you. You may also visit online brokerage agencies and do the same.
But it is advisable that you do not stick to a single tool. You had better get help from more than three tools to know how much life insurance you need. This is important because if one tool has any criterion missing, the other one will probably have it.
Is a Financial Adviser Necessary?
There are debates as to whether you need a financial adviser to get your life insurance need or not. For example, while Colin Lalley of Policygenius is in favor of consultation with a financial adviser for life insurance need determination, Robert Schmansky on Forbes categorically declines the need for adviser for life insurance needs calculations.
We, Life Insurance Mentors team also do not think financial advisers are necessary for getting to know your life insurance need. You may go with a formula, a combination of formulas or simply take the advantage of using the tools.
Finally, we would remind you once again to avoid lump sum figures and ask yourself: how much life insurance do I need? – We emphasize so much on the question because we know, like you do, questions beget answers.
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I love how you broke life insurance down into terms anybody can understand
We just pay the fee for the military. Should something happen to my husband, I will get a nice amount back, but I always hope nothing will. I think it’s also a good amount for the kids and I. Life insurance through the military is an excellent deal I’m told!
This is so interesting. I never thought about life insurance in this way. The denis formula sounds good and looks like it takes into factor everything that is really important.
We are in the process of looking in and picking out a life insurance policy. There are so many factors to be considered – we definitely don’t want too have to much or too little. Your post is so helpful and we will be following your guidance as we go through the process.
The insurance game is hard to play. My husband gets life insurance through work and I hope we have enough.
Figuring out insurance is always tricky but you have made it a little clearer.
You should choose less than you should have, life of your dependents could be affected. They would have less financial resources than they would need if you could not be physically there to support them.
This is really interesting I had no idea there was an optimal amount for people I assumed it was just the same sort of amount no matter who you were.
This sound so complicated! I have a life insurance because my parents opened one for me so i did not have to think about it but now that i am of age, i need to deal with it myself. I might have to change a few things
These kinds of things can get overwhelming to figure out for me. I am glad you broke the life insurance thing down so well!
I had a life insurance policy through my last employer that was a lump sum. Now that I’m self-employed I need to get a new policy. You’ve given me a lot to think about.
I have a friend who is really involved in insurance. These are all great things to think about when considering it. I will definitely be asking her when it comes to it.
Purchasing life insurance can be an overwhelming thing. Your information and breakdown is great for people to understand it better.
You never really know how important life insurance is until its too late. This is a great post. It breaks it down into terms anyone can understand.
XOXO
Elizabeth Keene
This is such an important and informative post! I never thought about things such as life insurance until I had my son, now if anything were to ever happen to myself or his father we need to make sure that he is taken care of. Thanks for the tips!