Life insurance is an essential part of your overall financial plan, providing peace of mind that your loved ones will be financially secure if you pass away. The amount of coverage you need varies depending on your financial obligations, assets, and life goals. Here are some methods to calculate how much life insurance you need:
Method 1: Financial obligations minus liquid assets
Follow this general philosophy to find your own target coverage amount: financial obligations minus liquid assets.
|Step 1||Step 2|
|Your annual salary multiplied by the number of years you want to replace that income||Liquid assets, such as savings, existing college funds, and current life insurance policies|
|Your mortgage balance|
|Any other debts|
|Any future needs such as college fees and funeral costs|
|The cost to replace services that a stay-at-home parent provides, such as child care, if applicable|
The number you’re left with is the amount of life insurance you need.
Method 2: DIME formula
This formula encourages you to take a more detailed look at your finances than the first method. DIME stands for debt, income, mortgage, and education, four areas that you should account for when calculating your life insurance needs.
|Debt and final expenses||Income||Mortgage||Education|
|Add up your debts, other than your mortgage, plus an estimate of your funeral expenses||Decide for how many years your family would need support, and multiply your annual income by that number||Calculate the amount you need to pay off your mortgage||Estimate the cost of sending your kids to school and college|
By adding all of these obligations together, you get a much more well-rounded view of your needs.
Method 3: Income replacement
With this method, you’ll buy enough coverage that your beneficiaries can replace your income without spending the payout itself. To calculate the amount, divide your annual income by a conservative rate of return, such as 4% or 5%.
When your dependents no longer need the income to meet daily living expenses, the payout can go toward other goals such as college tuition, home buying, or retirement income.
Keep these tips in mind as you calculate your coverage needs:
- Think of life insurance as part of your overall financial plan.
- Don’t skimp.
- Talk the numbers through with your family.
- Consider buying multiple, smaller life insurance policies.
Use the life insurance calculators on our website to get a more refined idea of how much coverage you need, and then compare that value to these estimates.
- Lighthouse Life Insurance Company. How Much Life Insurance Do I Need?
- Investopedia. How Much Life Insurance Do I Need?
- OneMain Financial. How Much Life Insurance Do You Need?
- Social Security Administration. How Much Life Insurance Should You Have?
- Federal Trade Commission. How Much Life Insurance Do I Need?