How To Determine How Much Life Insurance Coverage You Should Have?

Answer 1

If you listen solely to insurance agents, you’ll probably get the idea that you’re not adequately covered for life’s unplanned events. They’ll probably try to sell you on the idea of large policies that are necessary to cover even the remotest of possibilities.

The purpose of life insurance is to provide you with a way to replace the income of a family member who passes away unexpectedly so that remaining family members can continue with their normal lifestyle. A single person who has no dependents and nobody counting on them to be the provider may not need any life insurance at all. Those with spouses or young children should have life insurance to protect their dependents.

Thankfully, the determination of how much life insurance you need can be very simple if you just need a ballpark estimate or just a bit more complicated if you’re looking for a more precise number.

For the simple calculation, you need your significant other’s annual salary along with the expected return you could expect to receive should you invest that insurance money (using a 6-8% long-term Stock Market return could be considered reasonable although the return on the stock market has been much lower recently). To calculate, divide the annual salary by the expected return. For example, if you expect an 8% return and are replacing a $50,000 salary, you’d want about $625,000 in life insurance coverage.

For the more detailed calculation, you’ll want to replace the annual income number in the above calculation with a measure of assets versus liabilities. Here, you’d want to total your annual expenses like mortgage/rent payments, credit card bills, day care, groceries, electricity, etc. and measure it against assets you already have that would be used to cover those expenses like salaries, child support and cash accounts. Plug that number into the above calculation and you’ll get a number that might be a more situation-specific estimate of how much life insurance you should have.

Smart Money’s website has a useful Life Insurance calculator which would be a great starting point for anybody looking to find their own number.