Your life insurance is important because it covers your obligations when you’re gone.
It provides for your loved ones by leaving them a non-taxable amount during the transition time, covers your mortgage and personal loans, and supports your family’s income to ensure they can maintain their quality of life. So, how much life insurance do you need?
It’s crucial to determine as accurately as possible how much life insurance you need, as it differs from person to person. But before we get into your numbers, let’s take a look at the different types of life insurance available.
2 Main Types Of Life Insurance
Your coverage amount should consider both your short and long-term needs, which is why there are so many types of life insurance. The two main types are term and permanent life insurance.
Term Life Insurance: As its name suggests, a term life insurance policy matures only after a set period. Thus, it’s typically a cheaper option.
In general, you can choose a term of 10, 20, or 30 years. So, term life insurance is ideal if you are starting out to protect your family and yourself, especially if you are only looking for a temporary policy until, for example, your mortgage is paid off or your children are no longer financially dependent.
The advantage of term life insurance is that it’s inexpensive at first and easy to understand, allowing you to buy a lot more coverage than you could with permanent life insurance. But, overall, they’re best suited for young families, homeowners with a mortgage, and business owners because of their versatility.
Permanent life insurance: This type of insurance never expires unless you decide to pay premiums or surrender the policy, thus making it usually more expensive than the term.
Subcategories to watch out for include whole life insurance and universal life insurance. Whole life insurance provides coverage for the insured’s entire life, and its savings can grow at a guaranteed rate. Universal life insurance offers both a death benefit and a savings element, but it has different premium structures and earns according to a market index.
With permanent life insurance coverage continuing even if your health fails, and the cost usually never rising, it is an excellent investment from a long-term perspective. It is even more appealing if you have already made full use of registered investment accounts such as RRSPs and TFSAs.
How To Identify Your Coverage Needs
First, multiply your annual salary by the number of years you want to replace that income, then add your mortgage balance, your current and future household needs, and any other debts you have. This will give you the total of your financial obligations.
From this figure, you will subtract your liquid assets, including savings, existing college funds, and life insurance policies; the number you are left with is the amount of life insurance you need.
3 Simple Ways To Get An Estimate Of Your Coverage Needs
If you want to determine an estimate quickly, there are easier ways. They may not account for all the critical parts but are certainly much better than guesses.
Your Income x 10: One of the popular ways is to multiply your income by 10. So, if you’re making $60,000 annually, your amount would be $600,000.
However, this simplistic way of calculating your life insurance doesn’t pay regard to your savings and existing life insurance policies, as well as your unique family needs. Case in point, you could be a stay-at-home parent with no personal income, but that doesn’t mean you shouldn’t have coverage.
That’s because the value of a stay-at-home parent needs to be replaced with, for example, child care services or temporary housekeepers.
(Your Income x 10) + ($100,000 x # of children): Another way is to buy 10 times your income, plus $100,000 per child for college expenses. As you know, one of the biggest responsibilities parents have is ensuring their children receive the best education possible.
Therefore, if you are a parent, this method is perhaps better than the previous one because it considers your child’s college fund.
Still, this method doesn’t factor in specific family needs, assets, or any existing life insurance coverage.
DIME: Then, there’s the DIME formula. DIME stands for debt, income, mortgage, and education, which are all factors that should be seriously considered when calculating life insurance.
The difference between this method and the others is that it prompts you to think more holistically about your finances.
It works by adding up your debt (plus your estimated funeral cost), the number of years that your family will need support multiplied by your annual income, the remainder of your mortgage, and the cost of your children’s education.
Due to how comprehensive this method is, you’ll gain a broader perspective of your needs. However, it disregards your life insurance and savings coverage and the unpaid contributions you make as a stay-at-home parent.
The Important Aspects of Life Insurance Beyond Numbers
Besides using formulas to determine cold-hard numbers, there are other intangible considerations to keep in mind as you pick and plan your coverage needs:
Incorporate life insurance into your overall financial plan: Plan for future expenses, such as college costs and your income and asset growth.
Avoid underspending: The scale of your lifestyle will likely increase as your income increases over the years, resulting in higher expenses. While it is impossible to predict exactly how much either income or expenses will increase, ensuring you have a cushion allows your family to continue living a quality life regardless of your absence.
Communicate with family members: When estimating how much life insurance you may need, it is advisable to consult with family members involved since they might contribute perspectives on the matter. In addition, they may have other needs you are unaware of, or they may need less support than you believe.
Consider getting multiple minor life insurance policies instead of one big one: As you and your partner move through different life seasons, from the beginning of your marriage to when you have children, then to becoming empty nesters, your insurance needs could vary accordingly. For example, when you start a family or prepare your kids for college, you may want substantially more coverage, but you may need significantly less once you enter your golden years. This is why it’s crucial to find the right combination and balance between term and permanent life insurance policies.
Featured Image: Megapixl
