As with any insurance, buying life insurance puts you in a pickle:
You want to make sure you have enough coverage to protect your family and loved ones in case you die but you don’t want to play it so safe that the monthly premiums bust your budget.
Unfortunately, we can’t tell you exactly how much life insurance you need. That number is up to you and your family, and it’s different for everyone.
But we can help you figure it out for yourself.
4 Questions to Ask to Determine How Much Life Insurance You Need
Ask yourself these questions to determine whether you need life insurance and how much coverage you should buy.
1. Are You a Parent?
Having children is one of the most common forces that drives people to purchase life insurance. That makes sense: Your kids depend on you for everything, so you want to make sure they’re financially safe in case you die.
Even if you’re part of a two-parent household where your family doesn’t rely on your income (or you don’t earn income), consider life insurance.
Life insurance could help cover costs your family suddenly faces in your absence, like child care, housework or home maintenance. These costs could fluctuate significantly if the other parent has to change jobs or make other lifestyle adjustments once you’re gone.
Life insurance with benefits that you leave to your kids could help put them through college, which could be especially helpful if you’re otherwise planning to cover their education or living expenses while they’re in school.
To figure children into your coverage amount, take into account:
- How many children or other dependents does your household support?
- What current costs does your family rely on your income for?
- What, other than money, do you contribute to the household that would mean new costs for your family if you were gone?
- What future costs do you plan to cover for your children?
2. Does Anyone Else Rely on Your Income?
Whether or not you have children, are you in a relationship where the other person relies on your income?
Maybe you earn 100% or the majority of your household income for yourself and a spouse or partner. Maybe you support an older parent or a relative with disabilities. Maybe you have a unique financial arrangement with a roommate, friend or sugar baby.
Whoever it is, what would these people lose financially if you died?
Consider their current and future costs, including:
- Housing and living expenses
- Health insurance and health care
- Assisted living facilities
- In-home care
3. Which Lingering Costs Will You Leave Behind?
Other than basic living expenses, what are the costs you’ll leave to your family if you die?mThe most common costs to consider are:
- Funeral expenses. What kind of ceremony, memorial, burial or other traditions does your family expect to hold when you die? Regardless of any other financial responsibilities, many people buy life insurance just to cover these costs.
- Mortgage. If you share a mortgage with another person, they’ll remain responsible for repaying the mortgage balance even if you die. With the loss of your financial or domestic support, life insurance could protect them from being burdened with that debt.
- Credit card debt. Do you share credit cards with someone else? Just like mortgage debt, they’ll shoulder that repayment without you.
- Student loans. If you’re repaying federal student loans or a parent PLUS loan for your kids, the government will discharge those student loans if you die. But some private lenders aren’t so lenient reasonable. Some do discharge loans in case the borrower dies, but some don’t. They could try to recoup the debt from a co-signer (if you have one), or from your estate, which would cut into any inheritance your family receives. Student loan debt will not be directly transferred to your survivors.
- Personal loans. Personal loans will work like private student loans if you die. A co-borrower will remain responsible for the debt. In the absence of another borrower, the lender will recoup what it can from your estate.
- Taxes. Your beneficiaries will have to pay an Estate Tax if they receive a large inheritance when you die. The Estate Tax threshold for 2021 is $11.7 million, so maybe a lot of us aren’t worried about it. BUT your loved ones could face taxes on forgiven debt they shared — something a lot more of us probably should think about.
If you can, take out enough life insurance to pay off these costs for your beneficiaries. If you can’t afford or don’t qualify for enough coverage, at least consider the monthly costs of these debts when calculating how much runway you can provide.
Business owners, you’ve got more than just your family to think about when you’re considering life insurance.
If your business would stop functioning without you, or it would have to be sold to cover debts and other costs, consider the impact on your employees.
Take out enough life insurance to cover your personal and business debts to keep your business safe. And, for small businesses, you could name your employees as beneficiaries to give them a financial cushion in case the business is suddenly pulled out from under them.
4. What’s Your Annual Income?
Income replacement is one of the biggest factors most people consider for figuring out how much life insurance coverage to buy. Calculate your annual income multiplied by the number of years of runway you want to leave your family.
Starting with replacing your annual income can give you a good base understanding of how much coverage your beneficiaries might need. But don’t stop there.
Consider the factors we mentioned above — your family’s financial situation and needs will likely change after you die.
Plus, you might want to make a plan that sets them up for financial success in the long term, rather than just helping them weather the immediate consequences of your death.
The DIME Life Insurance Formula
How much life insurance you need to leave your loved ones is totally subjective — but experts love to make a formula for everything, so we can’t leave this out.
For years, financial advisors just advised a simple “annual income X 10” formula for life insurance coverage. Until they realized humans are all quite unique with a broad spectrum of life insurance needs And that humans who don’t earn an income still make a valuable contribution to a household.
The DIME formula gives more leeway for what’s actually going on in your life. It’s imperfect, but at least the acronym is easy to remember. It stands for:
- Debt: The amount of your non-mortgage surviving debt and funeral costs.
- Income: Your annual income and/or unpaid household contribution, multiplied by the number of years you want the death benefit to support your family.
- Mortgage: Your outstanding shared mortgage debt.
- Education: The estimated cost of your kids’ K-12 and higher education.
Life Insurance Example
To help you see how you might calculate the amount of life insurance coverage you need, let’s look at a hypothetical.
Kris and Sam, both 35 years old, are married with two children ages 2 and 3. They own a home together and share a mortgage with a $100,000 balance remaining. Sam has $25,000 in federal student loan debt, and the couple has $10,000 in shared credit card debt. Sam earns $75,000 a year, and Kris stays home with the kids.
At their age, Kris and Sam could each be eligible for pretty low rates for life insurance, so this is a good time to buy.
Considering their young dependents, they could each consider 20-year term life insurance, a common policy for parents that offers affordable protection throughout your kids’ childhood.
How much life insurance do they need? Sam should consider a term life insurance policy with:
- $100,000+ to pay off their mortgage balance and interest.
- $10,000+ to pay off their credit card debt and interest.
- $75,000 x 10 years for income replacement.
- $6,000/year x 3–5 years for child care costs.
- $2,000 to $10,000 for funeral costs.
- $100,000 x 2 for their kids’ education.
Sam would need a policy with around $1 million to $1.5 million in coverage.
That might sound like a lot, but it doesn’t have to be costly. Plenty of life insurance companies make it easy for you to sign up for life insurance online and get that coverage amount for less than $20 per month while you’re young and healthy.
Kris’ life insurance policy would probably be lower, but not a lot lower. While Kris doesn’t have an income to replace, Sam would likely be left with child care costs and other new expenses if Kris died.
For additional scenarios and unexpected life insurance considerations, check out our post on three types of people who need life insurance (and five who don’t).
Dana Sitar (@danasitar) has been writing and editing since 2011, covering personal finance, careers and digital media.