Most people understand how important life insurance can be for their family’s financial security, but few understand exactly how much coverage they should own.
According to the 2015 Insurance Barometer Study by the nonprofit group Life Happens and the insurance industry research group LIMRA, 43 percent of Americans would feel a financial impact within six months if their primary household wage earner died. They wouldn’t be financially prepared and would have to make drastic or significant financial changes if that happened. Life insurance can make the financial transition much easier.
How much coverage do you need?
Some experts advise having enough life insurance to cover five to 10 times your annual salary, especially if you have a young family. But the truth is, there is no one-size-fits-all answer and you should never follow a random formula. The ultimate answer for you depends on several considerations, and you should take time to carefully evaluate your unique situation.
Here’s a simple three-step plan to answer the “how much” question:
- Consider your family’s financial needs. How much does it take to run your household? Do you have a mortgage, unpaid medical bills, credit cards, student loans or other outstanding debts? You’ll also want to consider funeral expenses and any estate taxes. A life insurance policy can cover immediate expenses such as medical costs, as well as taxes, mortgage payments, funeral expenses and other debts.
- Evaluate future obligations and goals. Are you planning to pay for your kids’ college expenses? You’ll want enough coverage to pay for that and other future financial obligations. Take time to thoroughly evaluate your family's future financial needs and goals.
- Add up the available resources. Consider available savings, your spouse's income, estimated Social Security survivor benefits, and the balances in any 401(k)s, IRAs, and 529 college savings plans. Don’t forget any existing life insurance policies such as one you may have through your employer.
From there, it’s just a matter of doing the math. The difference between your family's financial needs and the available resources will give you a good estimate of how much life insurance you need.
Whatever you do, make sure you don’t let myths and misperceptions about life insurance cheat your family out of financial peace of mind. Unfortunately, cost is one of the biggest of those misperceptions. According to the Barometer Study, more than 80 percent of Americans actually overestimate the cost of life insurance, with Millennials overestimating the cost by more than 200 percent and Gen Xers overestimating by more than 100 percent. The bottom line: Life insurance is more affordable than you might expect.