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How Much Life Insurance Do I Need? – Typical Coverage Amounts

By Michael Lewis

life insurance policyWhen I was a young husband and father, I visited an old family friend who had been in the insurance business for ages. Being concerned about the future, I asked, “How much life insurance do I need?” The old pro looked at me and replied, “How long are you planning on being dead?”

I subsequently discovered that there are popular rules of thumb used to calculate the amount of life insurance you need (8 to 10 times your annual income is typical). I also learned that each person’s situation is different, and needs to change over time. As a consequence, you should assess your situation and your life insurance need each time a major event in your life occurs, such as a marriage, birth, home purchase, new business, death, or retirement.

How to Determine Your Life Insurance Needs

To get a rough approximation of your insurance need, consider the following:

1. Determine the Ideal Amount

  • Multiply your annual after-tax income by the number of years you expect the need to exist. For example, your spouse might need an after-tax income of $40,000 until retirement 40 years hence, or $1,600,000 in total.
  • Add the costs of major events (e.g., children, college, major future purchases). Continuing the above example, $1,600,000 of spousal need plus $500,000 for children would total $2,100,000.
  • Deduct the value of the net assets (assets minus liability) you own. For example, if you have $100,000 in assets, the $2,100,000 amount calculated in the previous step would be reduced to $2,000,000.
  • Determine the present value of the sum using a present value table or a financial calculator with 2.0% as the interest rate. The present value is how much you would need to invest today to arrive at your calculated future need. A growth rate of 2.0% each year is both conservative and realistic given historic investment performance and inflation.

2. Calculate How Much You Have Available for Premiums
Determine how much premium you can afford to pay presently, as well as during the term, after paying for other necessities like shelter, food, clothing, transportation, and health insurance.

3. Solicit Quotes From Multiple Insurance Providers
Be sure that you understand the underwriting requirements, and get quotes from at least three providers. Genworth is one option you can look into. For example, if you are a smoker, get the costs of a smoker policy rather than relying upon the advertised premium or what a nonsmoker with ideal health would pay. In the example above, a nonsmoking 25-year-old male in good health would probably pay a premium between $1,500 and $2,000 per year for $910,000 of term insurance.

4. Select the Optimum Owner to Purchase the Policy
While you are the insured life, the policy owner can be a trust, your spouse, or anyone else who has an insurable interest in your life. You must be sure you understand the tax aspects of any insurance proceeds to your beneficiaries upon your death. For example, the ownership of the policy could be held by the other spouse, thus avoiding estate taxes on the insurance proceeds which would be due if the covered spouse is also the owner of the policy.

There are legal requirements to ensure that the proceeds remain outside the estate, however. It is always wise to consult an estate planner or attorney when dealing with end-of-life issues.

family child life insurance need

Typical Coverage Amounts

With that process in mind, here are examples of a typical person’s needs of insurance coverage over a lifetime:

Pre-Marriage and Children

Young adults and married people without children usually don’t have a major need for life insurance. Other than funeral costs and payment of college loans and consumer debts, obligations are minimal. If both marriage partners work, don’t own a home, or accumulate significant debt, there is little need to buy insurance to protect one’s earning power since the survivor is likely to continue to work. In addition, a young surviving partner is likely to remarry. The amount of life insurance needed is usually less than $50,000 for either partner.

Purchase of a House or Incurring Major Debt

If you are single and no one else is obligated on the debt, the asset can be sold and the proceeds used for payment. If you are married and wish the asset to remain intact, the amount of insurance needed would include the remaining balance on the debt.

For example, if your mortgage is $200,000, your need would be $200,000. As the mortgage is paid off, the amount of insurance needed would decrease. However, you should consider the continuing cost of house insurance and taxes in your everyday living expense. Insurance for someone in this position probably ranges between $400,000 and $600,000.

Children

According to a recent study by the U.S. Department of Agriculture, the average cost of raising a child born in 2010 to age 18 is $226,920. College costs another $21,447 per year at an in-state public university. Again, the need for insurance to cover these costs decreases as you continue to live, work, and save. Initially, you might need approximately $300,000 in coverage for a newborn (including projected college costs); however, that cost reduces each year of the child’s life.

Remember, insurance is intended to provide the income you are not able to provide due to an early death; it is payable only if you die. A separate savings element, possibly in the form of the accumulated cash values in the insurance policy, is needed to cover such expenses if you’re alive. People with children should have a minimum of $200,000 per child in life coverage in addition to their other needs.

Starting a Business

Whenever a business owner dies, an estate tax is due. Life insurance is one way to provide liquidity when it is needed – unless you are prepared to sell the business.

If you’re in a partnership, all business partners will want to fund a buy-sell agreement with insurance. This ensures that they do not have to cover the costs of company obligations borne by the partner, and that they have available cash to purchase the deceased partner’s interests in the company from his or her heirs.

This type of coverage can be accomplished with joint life insurance with first-to-die coverage. Due to different legal and tax questions, this insurance need should be covered in a separate policy with different owners than insurance purchased to buy family security.

Death and Estate Taxes

By the time most people reach retirement age, there is little need for life insurance unless the person has a substantial estate (well above $1 million under current tax laws). In that case, especially when the assets may be difficult to sell or would require a hardship by the beneficiaries, many individuals keep life insurance in place solely for its liquidity value. If your estate is in this category, visit an attorney for a complete estate planning exercise – it will pay for itself in saved taxes.

Final Word

In the hustle and bustle of everyday life, we sometimes forget our financial responsibilities to our families and business partners. Owning life insurance is an act of love and provides peace of mind that our loved ones will not have to endure the loss of a spouse or parent with the additional burden of financial strife.

Why else do you believe life insurance should be purchased? Have you ever experienced an instance where the proceeds of a life insurance policy ameliorated the stress of an unexpected loss?

This post was inspired by Genworth life insurance.

Michael Lewis
Michael R. Lewis is a retired corporate executive and entrepreneur. During his 40+ year career, Lewis created and sold ten different companies ranging from oil exploration to healthcare software. He has also been a Registered Investment Adviser with the SEC, a Principal of one of the larger management consulting firms in the country, and a Senior Vice President of the largest not-for-profit health insurer in the United States.

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Comments

  • http://www.moneylicious.org/ Ornella @ Moneylicious

    These are really good tips and they are not just “rules of thumbs.’ I think what’s also important is understanding how life insurance policies work. For example, mine double as a life insurance policy and a retirement vehicle ( in addition to my other retirement accounts.)

    • Michaellewis

      Thanks for your comments. A cash value policy looks pretty attractive these days with the stock market returns for the past decade so pitiful. Congratulations on a good life plan.

      • http://www.moneylicious.org/ Ornella @ Moneylicious

        It does complement my financial plan. It has done well. I could always choose a more conservative allocation, as I do have that option. But I will say, if you want to maximize a cash value policy you have to understand how it works and know the costs. As a licensed financial advisor, these policies are not the right fit for everyone. Again nice article :-)

  • http://insurancesalesleads.com/ James Keller

    Insurance agents usually recommend coverage that will replace the equivalent of 15 times your annual income.

    • Michaellewis

      James,
      I certainly have no objections to a greater amount of insurance if one can afford it. My experience has been that most people don’t have enough, rather than too much. We probably agree that the “right” amount is a matter of personal circumstances, rather than simply following a rule of thumb (8 to 10 times- my suggestion or 15 times annual income – your suggestion).

  • Hadley Lewis

    Having been an insurance agent for a time and purchased life insurance for my spouse and I when we started our family I know how important the right amount of life insurance is to a family. It should be the first question you ask – how much life insurance do I need? Also, how much life insurance does my spouse need? A lot of families don;t quite understand the importance of having your family properly protected, including your spouse. Imagine all of the costs associated with replacing the efforts of a stay-at-home spouse if he/she were to die. The cost of day-care, laundry service, running errands, grocery shopping, cleaning the home, driving the kids to their activities, etc. If you are going to insure the life of the main-breadwinner in your family, make sure you consider insuring both spouses, since both of you contribute to the family in so many ways.

  • mlewis

    Hadley, thanks for writing. You are absolutely right. Insurance on both parents or any other member of the family whpse death would have a negative financial effect on the family should be considered for coverage.

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  • authentic

    Thanks for sharing .its nice information…

    • Michael Lewis

      I hope it is useful. Having life insurance is the first step in saving peace of mind. Thanks for writing.

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