How Much Life Insurance Do You Actually Need?
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How much insurance you need to buy depends on their future financial needs, your current situation and what your goals are when buying a policy.
The quick answer:
A simple estimate for how much life insurance you need is 10 years' salary. But that amount will change depending on how many kids you have, whether you've paid off your mortgage and how much debt or savings you have, among other things.
The more effective way to figure out how much life insurance you need is to add up your family's expenses and estimate how much money they'll need in the future. Then, subtract your financial assets.
The amount left over is how much life insurance you need to buy.
How to calculate the amount of life insurance you need
A good starting point for determining how much life insurance you need is to add together your current and future financial obligations, like your mortgage and kids' college funds. Then subtract all assets that could be used to settle your debts if you pass away — like savings accounts and a stock portfolio.
Step 1: Calculate current debts
Your life insurance policy should include enough money to cover all your debts so that your loved ones won't have to deal with them after your death. Add them all up, including:
- Mortgage
- Car loan
- Credit card debt
- Student loans
- Personal loans
Are debts passed onto my family after I die?
While many debts, like your credit card balance, aren't usually passed on to your family, the amount owed could be taken out of your estate before your family gets access to it.
If you have $50,000 in a savings account but $20,000 in car and personal loans, your family may only get $30,000. So you should account for the money you owe when buying a life insurance policy.
Do I include my mortgage in my debts?
Your mortgage is worth special consideration in your life insurance policy. It's one of the largest expenses of your life, and having it paid off with your life insurance policy will make your family's life much less stressful after you're gone.
If your family lives in your house and would continue to do so after you die, including enough coverage to pay off the house will ensure your family can stay put.
But if you live alone, your mortgage is paid off or your family would not need to keep the house after you're gone, you don't need to include it.
Step 2: Determine future expenses
Your life insurance policy should also include money your family will need after you're gone, both in the near future, for things like groceries, as well as later on, for something like a college fund.
- Funeral costs for you
- Your contribution toward ongoing household expenses like groceries, rent and vacations
- The cost to cover chores you do around the house, like cleaning and cooking
- Education costs for your kids (from preschool through college, as necessary)
- Retirement expenses for your spouse
When thinking about ongoing and future expenses, you can adjust the amount depending on how much of your family's overall budget comes from your salary. If your spouse makes more money than you, you can buy a smaller policy for yourself and a larger one for them.
But it's always better to buy more coverage, rather than less.
A standard term life insurance policy is not expensive for healthy people.
Don't discount the value of household labor, either. In a two-parent household, one parent can make dinner while the other does laundry or watches the kids. But if your spouse has to shoulder all of those responsibilities alone, being able to order food from a restaurant or use drop-off laundry service could make a huge difference in your family's comfort, should you pass away.
Paying for college
Paying for your kids' college is another one of the biggest expenses you'll encounter in your lifetime. As of 2021, the average cost of college can range from $15,000 to $56,000 per year, depending on whether your child attends a public or private university and whether they live on campus, off campus or at home. (These figures don't consider financial aid.)
The cost of college also tends to increase by about 22% per decade after inflation, so it's a good idea to add extra to account for the increasing cost of higher education.
Retirement (optional)
Including future retirement savings in your life insurance policy isn't a must-do, but it's worth considering, depending on your financial situation.
Determining how much to save for retirement is a complex question, but a good starting point is to have 25 times your annual income saved, assuming you live for approximately 25 years after you retire.
If you have been able to save a meaningful amount for retirement thus far in your life, you may not need to add much here. But if you are behind where you'd like to be, adding some extra coverage to your life insurance policy will keep your partner comfortable in their later years.
Step 3: Total your current assets
The next step is to add together your assets and other sources of income for your family. You'll subtract this number from your total financial obligations, including your family's future living expenses, to determine how much life insurance you need at minimum — you can always buy more as a buffer.
- Cash savings
- Taxable brokerage accounts
- Stocks
- College funds
- Estimated income of your spouse (post-tax)
When looking at your current assets, you should include brokerage accounts, savings accounts and any existing life insurance policies, such as through your job.
If your spouse works, include their income as well, either until your major financial responsibilities — most likely your mortgage and kids' college — are paid off, or until retirement.
However, you should exclude retirement accounts, such as a 401(k) or IRA. That's because for the most part, your family can't use that money for living expenses until they retire. You should also exclude the value of your home, unless your family would sell it if you die.
Step 4: Adding it up
Once you have the amounts of your current debts, future expenses and estimated assets, combine the first two and subtract the third to find the final amount of coverage you'd need.
This example is for a 30-year-old married couple who bought their house five years ago and have a new baby.
Current debts | Cost |
|---|---|
| Car loan | $8,000 |
| Mortgage (25 years left) | $350,000 |
| Credit card debt | $5,000 |
| Student loans | $10,000 |
| Current debt total | $373,000 |
| Future expenses | |
| Funeral | $10,000 |
| College fund (class of 2045!) | $300,000 |
| Day-to-day expenses (groceries, utilities) | $300,000 |
| Household labor (cleaning, cooking) | $60,000 |
| Future expense total | $670,000 |
| Financial assets |
What kind of life insurance do you need?
Once you’ve calculated how much life insurance you need at the moment, you should calculate how long you’ll need this amount of coverage.
For most people, a term life insurance policy is the best choice. A term life policy lasts a set amount of time, usually between 10 and 30 years, and once it expires, you don't get any payout. But it's also very affordable, so you can get all the coverage you need without spending thousands of dollars each year.
You can set your policy to expire after you've paid for your kids' college or your mortgage, or once your spouse has reached retirement age.
Penguin tip: You can buy multiple policies that expire at different times. If you have teenagers at home, you'll likely be done paying for their college in the next 10 years, but you might still have 20 years left on your mortgage. In that case, you could buy one 10-year policy and one 20-year policy so that you're not paying for more coverage than you need.
Some life insurance companies will also let you adjust the level of coverage you have as your needs change, but not all.
The other option is a permanent life insurance policy, which stays in effect for as long as you keep paying into your policy. Many permanent policies eventually become free, meaning they continue to go up in value without you contributing any more money. Whole life and universal life insurance are the two most common types.
But permanent life insurance is much more expensive and complicated than term life, for the same dollar amount of coverage. Almost everyone will be better served in the long term by purchasing a term life policy and saving or investing the difference, especially if they can take advantage of tax-advantaged accounts like an IRA and 401(k).
There are a few cases where you might consider a permanent policy.
- Low-value policy to cover end-of-life costs: For people with low incomes who don't have enough saved to cover end-of-life expenses, it might be worth getting a relatively cheap permanent policy that provides just enough for expenses like a funeral and burial plot or cremation — under $50,000.
- Asset diversification for wealthy people: If you have a high net worth and have already exhausted other retirement savings avenues like a 401(k) and IRA, it's possible that a permanent life policy can help you pass on more of your estate to your heirs. But this is very situation-specific, and you're best off talking with a financial advisor before committing to buying a permanent life policy.
Whether you buy term or permanent coverage, try to make sure your policy’s monthly costs stay the same for the entire time you're covered — it's often called a level-premium policy. When this isn’t specified, the insurance company can raise your rates and you may not be able to afford the coverage later, even though it’s still needed.
When do you need life insurance?
There aren't many situations in which you are required to buy life insurance, but there are several situations when you might want to get it.
Many people choose to purchase life insurance because it can provide financial support to their families and loved ones if they pass away. Some of the most common costs that life insurance is used to cover include paying for your funeral and children's education.
Expense | Value of life insurance |
|---|---|
| End-of-life costs | Whether you’re buried or cremated, the costs associated with your passing can range from $2,000 to over $10,000. |
| Mortgage | Having enough coverage to pay off your mortgage ensures your family will be able to stay put if you pass away. |
| Children’s education | Your children's college is one of the biggest expenses you'll have in your life, often costing between $20,000 and $60,000 per year. |
| Standard of living | Life insurance can help your family pay for day-to-day expenses after you pass away. |
| Estate planning | For people who've already exhausted other tax-advantaged savings options, life insurance can be one part of your plan to pass on your estate after you die. |
There's no single age when you should buy life insurance, except for when you have dependents who you're responsible for. You don't need to buy life insurance at 25 if you're single and without kids, and it might still be worth getting at 55 if there are people who depend on your income to live. But remember that the sooner you buy a policy, the more affordable it will be.
When life insurance is required for businesses
There are a few situations when you might be required by the terms of a contract to buy a life insurance policy. They mostly relate to people who are crucial to business ventures, like CEOs.
- If you’re taking out a large loan and the lender requires coverage as a form of collateral. You’ll want the death benefit to be equal to or greater than the loan in these cases. You can use a collateral assignment so the lender will only be paid back the outstanding debt, while your beneficiary will receive the rest of the payout.
- If you’re taking out a business loan or receiving funding and a requirement of the investment is that you have key man insurance. This life insurance policy is taken out on a founder or person that the business would have trouble functioning without. Key man insurance pays the business if you pass away, providing capital to hire a new employee or repay business loans.
Sources
Costs of college and changes over time were gathered from the National Center for Education Statistics.
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