How Much Life Insurance Is Enough?

One of the most common questions that people have when purchasing life insurance, is how much life insurance is enough? This is certainly the right question to ask, because if you were to die, then your family needs enough money from your policy to survive without you and your income. Get the coverage of your policy wrong, and your family could very well end up struggling financially and suffer from a reduced quality of life.

However, trying to decide how much life insurance you should buy is not as easy as you might think. This is because there are so many factors which can influence how much coverage you need and how long you need it for. So what may be enough for one person, could be totally inadequate for another.

The good news is that once you become aware of all the different factors which can influence your life insurance coverage limit (which we will discuss later on), it then becomes a lot easier to take out the right policy and to take out a policy that is going to do what you intended it to do. This is turn will help to give you peace of mind, as you will know that your loved ones will be well looked after if you were to die unexpectedly.

Cautionary Note

In this article, we will look at how you can determine how much life insurance you should be taking out, or more specifically, what sort of dollar limit coverage is likely to be enough for your needs.

It should be noted however, that without meeting someone in person and discussing their specific needs and requirements for a life insurance policy, it is impossible to give an exact number on the amount of coverage that they are likely to need.

This is also true for the various life insurance calculators, such as this one, that you can find online. Although they can be useful for giving you a rough idea, ultimately, the best way to determine how much life insurance you should buy is to speak with your insurance agent. As this will help to give you a much more accurate idea on the amount that you should be insured for.

But with that said, it still is very useful if you can form a rough idea as to how much insurance you need by yourself, as this will help you to determine whether the figure given to you by your agent is too high or too low. It is also worth bearing in mind that because agents work on a commission basis, you may want to get estimates from two or three different agents just to make sure that you are being given an accurate value for your policy limit.

Factors That Influence Life Insurance Coverage Limits

It is impossible to get a value for your life insurance coverage limit without first making an assessment of your current lifestyle and financial situation. Some of the factors which may influence how much life insurance is enough for you to provide your dependents with financial security are listed below.

1) Debts & Financial Obligations

If you are currently in debt and you were to die, it is important to realize that your family may be responsible for your debt. You therefore want to take out enough life insurance to at least cover this debt.

There are many forms of debt that a person may be responsible for. Most people tend to think of credit cards when they hear the word “debt”, but debts can also include the mortgage you have on your home, any financing you have taken out on your car or any loans that you have taken out for other purposes such as for a business.

All of your debts and financial obligations should be added together to determine how much money you currently owe, and how long it is likely to take to repay those debts.

This figure should then be used to determine part of your coverage limit if you also want to insure your dependents against other expenses they may incur. If you do not want to insure your dependents against other expenses, then you can obviously use this value as it is.

2) How Much Money You Earn

The amount of insurance that you take out should be enough to cover your income for a set number of years. This is important if you want your dependents to be able to maintain the same standard of living as they are currently used to if you were to die.

Your current level of income can therefore determine whether you are likely to need a high or low coverage limit, as those on a high income are likely to live a lifestyle that is associated with high expenditure and the purchase of high value items. Conversely, those on a lower income are likely to live a lifestyle that is associated with low expenditure and the purchase of lower value items.

One common mistake made when taking out a life insurance policy based on your current level of income, is to assume that your family’s expenses would fall if you were to die because there would be one less person in the house. In some cases, this may be true. But if you have children, then your spouse may need to hire help to carry out the tasks that you used to do. This could potentially result in higher monthly outgoings than when you were still alive.

For example, a husband may be used to having his wife look after the kids and clean the home. But if she were to die unexpectedly, then he may then have to hire a nanny and a cleaner so that he can continue going to work.

A wife may be used to her husband mowing the lawn, repairing broken items and decorating the home. If he were to suddenly pass away, then she would most likely need to hire someone to do the things her husband used to do. Otherwise, she would be unable to continue looking after the children.

As a result, if you do have children who you would like to support with your insurance policy, then be sure to take such factors into consideration as you may discover that you need to insure them for more than you originally thought you would.

3) Number Of Children

If your children are at college or university, or plan to go one day, your life insurance needs to be substantial enough to provide for these educational expenses. For younger children, especially newborns, you should also take into consideration expenditure on clothes, food, toys, decorations and other items that you may need for your newborn.

Another factor that can influence how much insurance you need to carry is the length of time that you would like to provide coverage for your children. For example, if you have teenagers in the home, then they may only need to be insured for 5 years to see them through college or university. For newborns however, you may choose to take out a substantially longer coverage period of 10-20 years to insure their childhood and teenage years of life.

Finally, the number of children that you have is also likely to affect how much coverage you need, as in general, you can expect to increase your coverage limit in line with the number of children that you have.

4) Dependents

The more people who you have dependent on your income, the more coverage you need to take out, and if you are the sole income provider, then you will need more coverage still. Dependents can include children, both young children and adult children, and your spouse.

Note: If you have someone who is currently dependent on your income but can support themselves if you were to pass away, then you may want to exclude them from your list of dependents to save money on your policy.

5) Savings & Assets

How much money do you have saved up? If you have a lot of money put away in the bank, or other forms of assets, then your family may be able to survive financially in your absence. You may therefore not need very much life insurance coverage. If however, you don’t have much money saved up, then you are likely to require a more expansive policy.

You can also make a projection of your estimated savings and assets in the future, and then use that value to reduce the coverage limit on your policy if necessary. Be careful when making such adjustments however, as if you do not reach your targets, then your policy may not be able to provide adequate financial protection for your dependents.

6) Insuring Against Inflation

Prices rise each year due to inflation. Your insurance policy therefore needs to be large enough to cover the rising cost of inflation, otherwise it won’t provide adequate coverage for your dependents. The further into the future you  are intending your policy to cover, the more you will need to take inflation into account when deciding upon a limit for your policy.

So start thinking about how prices change for items such as food, clothes, gas, utility bills and any other common expenses that you currently have from year to year. You should then be able to get a percentage figure for how much prices are likely to increase throughout the coming years, and then to use that value to adjust how much life insurance you need to buy.

Rule Of Thumb Life Insurance

Although it is impossible to simply guess at how much insurance will be enough, you can get a general estimate using rule of thumb to help you determine roughly how much coverage you will need in your policy.

Most life insurance agents recommend that you take out a policy that equals at least five times your annual income. This value however, does not include inflation. To include inflation coverage, it is recommended to have at least seven to eight times your annual income.

If you have children, it is recommended to get as much insurance as you can afford. Considering that life insurance is relatively inexpensive for young families, you should be looking at somewhere in the region of ten times your annual income for a family with two children.

Ballpark Figures

If you have a family, $500,000 worth of life insurance is usually enough to provide adequate financial coverage for them. Half of this, $250,000, can be used for any services that are required in your absence such as work that needs to be done around the home or garden. The other half can be used directly by your spouse and children for their everyday needs.

Of course, these are not firm values, and you can divide the policy anyway you please. But, it is very important to take into account additional living expenses that your family may incur, and not just coverage for your current income.

Alternatives

Not everyone chooses to take out a life insurance policy. This may be because they cannot afford to do so, or because they want to use an existing asset to provide for their dependents.

Below, you will find two commonly considered alternatives to life insurance, and whether they are a good alternative to use.

1) Pension Plan/401k

Some people may consider using retirement money to provide for their spouse. However, this is generally not recommended, as that money will still be needed by your spouse when they retire. So try to avoid this option if you can.

2) Home Equity

Another source of income that is often considered, is using home equity to provide for a spouse. Again, this is not recommended, as it is not very liquid and your spouse would most likely want to keep the house after your death.