The time no one could have predicted has finally come: life insurance becoming a hot topic. From financial “gurus” to youtube superstars, life insurance has found its way into conversations far and wide, old and young. But really, what is life insurance and what’s the big deal? Keep reading to leave with some answers and hopefully not more questions than you came with.

How much life insurance do you need?

Now trying to figure out how much life insurance you need can seem like a daunting task. I know what you’re thinking, “Do I even need life insurance?”. Well if you have loved ones who depend on your income or might be burdened by your debts if you turn out the lights, having the right financial resources like life insurance in place becomes more than just a nice to have. Remember, life insurance is not for you (well it could be, more on that later), it’s for your loved ones.

Key Takeaways

  • How much life insurance you need depends on your financial and family situation
  • In general, the younger and healthier you are the less your premiums will be
  • Having enough life insurance to cover major debts and additional interest like mortgage, student loans, car, and others is a good minimum
  • There are various “rules of thumb” that are used to total the ideal amount of life insurance coverage you need
  • Private life insurance (you purchased) stays as long as you pay your premiums vs life insurance provided by your job in a group plan expires 1 month after being terminated.

What factors go into determining how much life insurance you need:

There are so many things to consider when choosing a life insurance policy and the coverage you are going to need. Because everyone's situation is different, the coverage amount that you need will likely be different from what someone else requires. For example, Beyonce is probably going to have less to worry about than most people reading this article. With that, financial experts often agree that purchasing 10 to 15 times your annual income in coverage is a good place to start although your personal amount may be higher or lower. Below are some of the most important factors for choosing how much life insurance you will need.

Debt

Who doesn’t love debt? It’s the gift that keeps on giving. Life insurance is often used to cover any pre-existing and foreseeable debts. Some of the most common are:

  • Student loans
  • Mortgages
  • Car loans
  • Credit Cards
  • Personal Loans

I cannot stress this enough, don’t be that person (I definitely didn’t do this….) who forgets to account for interest on loans. Not accounting for interest is such a common pitfall when calculating your coverage. I mean, it may as well be right up there with forgetting that grocery item that made you go to the store in the first place ( who's with me!? 🙋♂️).

When breaking down your debt, plan out the amount of interest that is going to be added by the end of that loan. It is better to overestimate than underestimate. Your loved ones (might) thank you.

Income Replacement

Income replacement is often one of, if not the biggest, factor for choosing your coverage amount. For example, if you are the sole provider and make $60,000 a year you will want a policy that is large enough to replace your income for several years plus a little extra to account for inflation. Simple enough right? But if you need something even more laid out there are a lot of online insurance estimators that can help you determine just how much coverage you will need.

Top 3 methods to estimate how much life insurance you need:

Method #1: Use the DIME formula

The formula is used to take a more detailed look at your finances and to calculate a more specific number. DIME stands for debt, income, mortgage, and education, the most considered factors when determining your life insurance needs.

  • Debt and final expenses: Simply add up your debts (not including your mortgage) plus an estimate of your funeral expenses. 
  • Income: Multiply your annual income by the number of years you decide your family would need the support. 
  • Mortgage: Your existing mortgage amount PLUS any additional interest. 
  • Education: Estimate the cost of sending your kids to school and college. (as mentioned earlier, $100,000 is a common number used per child)

By adding all these expenses you are able to get a much more accurate read on you and your loved ones needs. Although this formula is a bit more detailed than other methods it also doesn’t account for existing savings or other coverages you may already have.

Method #2: Multiply your income by 10

This is often the most shared “rule of thumb” for calculating life insurance. You take your income and multiply it by 10 and there you have it. In general it will give you pretty extensive coverage for debts and final expenses. Also take into account the value of a stay-at-home parent if that’s your situation. This parent would also want coverage to account for all the services that they provide (which is abundant). At a minimum the remaining parent would have to pay someone to fill services like child care for example which is usually around $1,000 a month.

Method #3: Multiply 10 times your income plus $100,000 per child for college expenses

This formula adds an additional layer to the “10 times income” rule by including coverage for your children's education needs. College and other education expenses add up fast and having coverage for these expenses is important to include. Again, similar to the 10 times income, it doesn’t take into consideration existing savings, your family's needs, or any additional coverage that may already exist.

Commonly asked life insurance questions:

Do I lose my life insurance if I lose my job?

This topic comes up a lot and so I think it is important to have a note about it. Life insurance offered through your employer is called a group plan. So if you ever leave or are terminated from that employer, your life insurance also generally expires 1 month after that date. Because premiums continue to increase with age it’s a good idea to consider getting a private policy that will stay with you regardless of your employer while keeping a better rate.

Age and life insurance

It’s no secret that your age plays a role in your premium amount. But just because you are younger doesn’t necessarily make it easier for you to qualify for a policy. You can get declined for various factors like certain pre-existing health conditions, criminal records, and others. Note that life insurance companies will often cover many pre-existing health conditions so don’t be put off if that is you. The best idea is to get life insurance when you need it, not because you're afraid of qualifying later in life.

Can you cash out your life insurance policy?

This all depends on the type of life insurance you purchased. Universal or whole life is a permanent life insurance policy that accrues cash value. Because of this you can often borrow against or withdraw some or all of that value. Doing so typically reduces the death benefit proportionally to how much you take out and in the case you take the entire amount you will lose all of your coverage.

Term life vs whole life insurance

As mentioned above, whole life is permanent life insurance meaning it will usually stay with you forever. Whole life also accumulates cash value that people sometimes plan to use as an income later in life. They are often touted as another way to save or invest money for retirement because you are able to build a pool of capital that gains interest. This happens because the company is investing that money for its own benefit similar to banks. So in turn they pay you a percentage for use of your money.

One caveat I will note is to do your homework thoroughly if your goal is retirement. Compare different types of funds and investment programs like an index, roth ira, or any other and you may find better returns in the end.

Term life (which is length based) is usually offered in 5 year increments from 10 years up to 30. Because there is a set term to this insurance, there are no funds to withdraw or cash out. The advantage of term life insurance vs whole life is that term is often much less expensive. Where a 30 year term life could be $400 a year, a whole life equivalent could be around $2,000 a year. This significant difference in cost makes term life an ideal option for most people since you can get the coverage you need at an affordable cost.

How to purchase a life insurance policy

Purchasing life insurance before meant finding your local agent, setting up an appointment, going through your details before getting an offer “potentially” offered. However there are many new companies like Waffle Insurance that make getting life insurance both simple and fast. Just visit our site, choose life insurance and fill out a few health questions. You can get an estimate in about 60 seconds and a policy in about 5 minutes. Waffle’s underwriter is also one of the biggest in the industry with an AM Best A+ rating meaning you can feel confident about your policy in the long run.

Tips for calculating how much life insurance you need:

Here are some additional tips to keep in mind as you calculate your coverage and loved ones needs:

  • Life insurance should be thought of as a part of your overall financial plan. This plan is to take account for any foreseeable future expenses such as inflation, assets, income growth, medical expenses, and anything else.
  • More is better. If you are deciding on a number or less because you expect your debts to decrease, choose the higher number. Companies like Waffle Insurance allow you to change your policy coverage and month premiums at any time without getting a new policy. This is helpful as you can change your coverage amount to be larger or smaller as your debt shrinks or increases.
  • Talk to your family. Your spouse likely has other expenses in mind that are going to be important. Things such as term length is also important to consider such as coverage until you retire or until the kids finish college. These are discussions worth having.