How much life insurance you really need

Determining adequate life insurance coverage is an important financial planning decision. While rules of thumb exist, your specific amount should be based on a thorough assessment of obligations and needs. Here are some tips on calculating an appropriate amount of life insurance:

Consider any debts

If you or your co-breadwinner died tomorrow, outstanding debts like a mortgage, car loans, student loans and credit cards would still need to be serviced. Tally all debts and target coverage that would pay them off, so they don’t fall to a surviving partner or family.

Factor in funeral costs

Sadly, end-of-life expenses must be accounted for. Average funeral costs often exceed $10,000 in the U.S. Sufficient life insurance can cover your funeral wishes without burdening loved ones.

Include recurring expenses

Think about ongoing household expenses like utilities, groceries, childcare and insurance premiums. Match life insurance to several years of replacement income that could cover these core necessities for family left behind.

Account for family members

For families with children, estimate the total costs of reasonably providing for dependents until they reach adulthood, including clothing, food, activities, college savings and other childcare needs.

Consider existing assets

The more assets like savings, retirement accounts and investments you have, the less life insurance you may need as a replacement income source. But don’t overly reduce coverage based on assets that won’t fully replace income.

Determine time horizon

Consider the number of years insurance needs to cover costs like keeping a child in school. Policies with longer terms, like 20 or 30 years, better match longer obligations. Term policies are ideal for this purpose.

Think about one-time costs

Major one-time expenses following a death include taxes, medical bills and any debts against the deceased person’s estate. Identify these costs in your calculation so they don’t undermine finances.

Factor in inflation

The purchasing power of insurance coverage declines over time with inflation. When opting for longer terms, choose a policy that increases the death benefit over time or buy a rider to keep up with rising costs.

Avoid underinsuring

A common mistake is purchasing too little insurance. Have an objective third-party review your coverage assessment. Build in buffers, since it’s impossible to exactly predict all costs.

Get quotes annually

As your financial situation and obligations change, reevaluate insurance needs during annual enrollment periods. Adjust coverage up or down accordingly to right-size based on circumstances.

Calculating an appropriate amount of life insurance is not guesswork. Do your due diligence through a methodical review of debts, income replacement and future costs. This better protects your family’s financial security.