How much life insurance do you need (if any)?
Posted June 8
Before we deal with the downer of your death, let's talk about your life.
Does anyone depend on you? Like, financially, depend on you?
Then you're probably fine without life insurance.
Of course, there are certain circumstances in which a single person with no one financially dependent upon them would need life insurance.
But, generally, financial advisers say young, single, childless folks can focus on paying down debts and building up savings first.
If, however, you have a spouse or children, you need to think seriously about what their lives will look like if you die and they discover there's no backup plan.
Here's how much life insurance you'll need to take care of them.
Do you even need life insurance?
Even if you don't have kids, you may still need some insurance, says Cliff Wilson, an insurance agent in the Phoenix area and former chair of LifeHappens.org.
Perhaps you run your own company? You should have life insurance (your employees are counting on you). Or you could have massive debts you don't want to saddle your parents with when you're gone.
Maybe you're a young and single financial overachiever making maximum contributions to your retirement account and sitting on a fully-funded emergency account -- go ahead get life insurance.
The price will be driven down by the two things you've got going for you (besides being on top of your financial game): you're definitely younger and probably healthier now than you will be later.
So while it may not be necessary, if it's within your means why not help out your family members to cover your funeral costs and go through a grieving process without worry?
Calculating your family's needs
One guideline about how much life insurance you need is to calculate 10 times your yearly income.
But Wilson cautions against such generalities. "I stay away from rules of thumb," he says. "There is a lot of information that has to be taken into account like your income, your debt, any businesses, the number of children, if there's credit card debt, mortgages."
Estimates based on income also don't give much guidance to people who are not employed. Particularly a parent who primarily cares for children. That parent needs life insurance, too, so that -- at the very least -- the surviving parent can cover the childcare and home maintenance costs that had been provided for free.
To get to your specific number for the amount of life insurance you should have, you'll need to calculate how much your family will need at the time of your death.
Here's the formula: take your family's debt obligations left behind and cash needs going forward then subtract the assets you have.
Debt obligations take into account things like mortgages and other debts. They also include outstanding credit card, personal loan or auto loan debts. These costs should be known now.
But there are also debt obligations that may be unknown. You'll need to estimate any future education costs and to account for final expenses like medical bills, funeral and estate-settling costs that you leave behind.
The other part of getting to the number of what your family needs, is to determine their cash-flow needs to sustain the household going forward.
Here's where your income -- that your family will lose upon your death -- comes in.
"The higher your income, the higher your responsibilities and typically the higher your spending," says Wilson. Consequently, the more insurance you'll need to cover its loss.
Offsetting needs with assets
But, the good thing is you have assets. You have liquid assets, right?
What you have available to go toward your family's ongoing expenses -- in cash savings, college savings or other life insurance -- should be subtracted from their needs.
Here's a back-of-the-envelope example. You earn $50,000 a year and are married with 5-year-old and 3-year-old children. You and your spouse owe $100,000 on your mortgage and carry $15,000 of debt on your car and credit cards. You're looking to get a 15-year life insurance policy that will cover you until your youngest is out of high school.
You'll take those obligations together with $750,000 in income replacement ($50,000 for 15 years), $200,000 for the anticipated cost of two college educations and $9,000, the average cost of a funeral.
That's a grand total of $1.074 million.
From that you're going to subtract what you already have going on.
Maybe you have $15,000 in college savings, $30,000 in cash savings and a $100,000 group life insurance policy through your job (up to two times your $50,000 salary). Those are your assets.
That leaves you with life insurance needs of around $929,000.
You'll need to conduct your own calculations. Your spouse's earnings, taxes, earnings from investments and inflation also play a part. Fill in your own numbers using the calculators at LifeHappens.org.
"It is important to protect our families and the people who depend on us," says Wilson. "Most everyone is responsible and loving, they just don't act because they think they can put off until later."