When you purchase a life insurance policy, you must decide how much coverage to buy. While no one answer is right in every situation, there are a few methods that people commonly use to determine how much life insurance they need. Take a look at three ways you can decide how much life insurance to buy.
1. 7 to 10 Times Your Annual Income
A common starting place is to look at policies that provide 7 to 10 times your annual income in coverage. For instance, if you make $50,000 a year, this would equate to a policy that offers between $350,000 and $500,000 worth of coverage.
If you’re a stay-at-home parent, you can follow this guideline but use childcare costs instead of annual income. The amount your family would have to spend on childcare if you passed away is an economic benefit that you provide to the family and would have to be made up if you couldn’t provide childcare.
Additionally, make sure you account for all of the income your family relies on. If you work a side gig in addition to a main job, don’t forget to include the income from that side gig in your calculations.
This initial starting place is far from a hard-and-fast rule. It’s much more of a guideline that can get you started in your search for life insurance. Part of the reason this guideline is initially used is simply because the math is easy. Don’t be surprised if you purchase outside of the 7 to 10 times your annual income once you start crunching specific numbers.
2. Base Amount Plus $100,000 per Child
Building on the above calculation, some people add $100,000 per child to the above guideline. If you made $50,000 annually and had two children, this method would result in a policy that afforded $550,000 to $700,000 in coverage.
The primary purpose of adding $100,000 per child is to cover the cost of college. The average cost of a year at a private college is now $50,900, and an in-state school costs $25,290 on average.
- Whether $100,000 would fully cover the cost of attending college depends on many factors, such as:
- Whether the $100,000 was invested to earn interest before the child’s college years
- What school the child chose to attend college at
- What other financial resources the child and their family have access to
- Whether the child receives any merit-based scholarships
- Whether the child receives any financial aid package
With so many variables, determining exactly how much future college will cost is nearly impossible. A $100,000 fund to help pay tuition and other associated expenses will cover a large portion of any college costs, however.
3. Base Amount Plus Any Outstanding Debts
Many people who are in substantial debt also add the balance of their outstanding loans to the initial base amount. Some debts that you might add include;
- Home mortgage
- Credit card debt
- Other consumer debt
- Medical debt
The one loan that you don’t need to include in this calculation is any loan on a primary vehicle that only you drive. If you pass away, this vehicle can be sold to pay off the associated loan since no one else uses the car.
Additional coverage for debt may be added to the base amount only, or the medical consideration can be combined with the $100,000 per child addition.
Building on the previous example, assume you also have a $125,000 outstanding mortgage balance. This would push your life insurance coverage up to $675,000 to 825,000, which is substantially more than the initial 7 to 10 times your $50,000 income. The additional amount provides important protections, though.
For help finding life insurance that offers all of the coverage you need, contact a knowledgeable insurance agent at Phillip R. Davis & Associates.