If you’ve spent time looking at information about choosing the right amount of life insurance, you’ll have found some fairly standard answers, but also a lot of ambiguity. That’s because the amount of life insurance a person needs varies on a case-by-case basis. Still, just like with other kinds of financial management, industry experts have weighed in on what they feel is best for the average consumer.
One of these rules of thumb is taking out life insurance coverage equal to five to 10 times your salary. To many of us, that sounds like a lot of money. It’s only when you get into the details of figuring out how people use money over time that you realize that five to 10 times salary can actually be a pretty conservative estimate.
Here are some of the considerations you’ll want to think about and take into account:
When you get into the details … you realize that five to 10 times salary can actually be a pretty conservative estimate.
1. Replacing salary in the home. One of the most basic ideas about life insurance is that you need enough to last a certain number of years, when your salary won’t be coming in. This involves calculating a person’s “time to retirement” and how much money they are projected to earn in the next five, 10, 15, 20 or more years.
Another way to put this is that you can try to figure out how much the household will have to deal with in terms of expenses each year, and multiply that by the number of years you’ll need coverage for. This is a fairly straightforward way of doing life insurance calculations.
For a working idea of your life insurance needs based on some straightforward inputs, trying using this easy Life Insurance Needs Calculator.
2. Living on interest. There’s another interesting idea that a lot of experts have put out there: The idea that with a large enough death benefit (what the policy pays out), a family would be able to live on the interest for a long time.
Take a death benefit of an even $1 million. Using a very simple calculation, you’ll find that at a 5% interest rate, that $1 million dollars would generate $50,000 per year. Then take a look at your current stock market, trust fund and investment fund opportunities, and see whether you can get something close to 5%.
After adjusting for market circumstances, you can figure out how your household might achieve capital gains on the proceeds of a life insurance policy that’s roughly even with the projected salary.
3. Age of dependents. Another major issue is the age of dependents in your household. For example, if your two kids are 15 and 17 years old, you may only want a few years of coverage. On the other hand, parents with new babies and toddlers will want policies that provide for a much longer time.
All this is to suggest that when it comes to life insurance, you may need more than you think you do. Plus with the low cost of premiums for most life insurance policies, it makes sense to get an amount that’s really going to pay off if it’s needed. After all, that’s just what this is—insurance.
If you have any doubts, talk with qualified insurance agent or advisor to figure out how to get the coverage you need at prices you can afford. And that chat won’t cost you a dime.