Sunday, September 25, 2016

How Much Life Insurance Do I Need?

One of the most common life insurance questions I get is how much life insurance do I need? Below, I walk you through 6 simple steps to determine the right amount of life insurance for your situation.

Here's the basic formula then I walk through it in more detail below along with an example.

  • ADD: Funeral expenses
  • ADD: Pay off mortgage
  • ADD: Pay off debt
  • ADD: Provide for college
  • ADD: Income replacement
  • ---------------------------------
  • TOTAL: Life insurance needed
  • SUBTRACT: Current cash
  • SUBTRACT: Life insurance already in force
  • ---------------------------------
  • TOTAL: Life insurance needed

STEP 1: Start With An Amount For Funeral Expenses

Unfortunately, when you die, you have to pay for a funeral. Feedback I've received from people I've talked with who have actually paid for a funeral lately say it's around $10,000.

Since most of us don't believe we will die today, it's a good idea to estimate what a funeral would be when you are older. It's a good idea to calculate out what a funeral would be estimated to be when you are more likely to die.

To keep it simple, add $10,000 for every ten years you are away from 80. So if you are 40, that's 4 decades until you are 80. So take $10,000 times 4. That equals $40,000. Add that to the initial $10,000 and now you have $50,000.

This is the amount of life insurance you would start with.

STEP 2: Pay Off Your Mortgage

This is pretty simple. If you have a $175,000 mortgage that's what you would add to your total. If you don't have a mortgage and only rent, it might not be a bad idea to consider adding the amount your rent would be if it was a mortgage. To make it simple, I'd add $100,000 for every $1,000 in rent you pay each month.

Add whichever number applies to you to your total.

STEP 3: Pay off your other debts

Add up all your credit card debt, your auto loans and anything else you owe other people and add that to your total.

STEP 4: Provide money for college

For each child, add $100,000 for the cost of a four year education.

STEP 5: Provide income replacement

I'd approach the income replacement one of two ways. The first way is to take the annual income you want to replace and multiply by a certain number of years you want to replace it for. I would suggest no less than 5 years as a multiplier.

The second way I'd do it is take the annual income you want to replace and divide it by 4%. This money if invested at a 4% return would that annual income each and every year.

This will provide a larger number than the first option. Sometimes, this makes people uncomfortable and it's easier to think in terms of a smaller number.

Whichever way you go, add this number to your total.

STEP 6: Subtract current cash and life insurance in force

After you have your total, subtract any cash you have saved up in savings and retirement. This will give you your final life insurance you need number.

Real World Example

John is 35 years old. He has two kids and makes $85,000 per year. He owes $125,000 on his mortgage and has two auto loans that total $27,000. He also has a few credit cards that total $12,000. His cash in savings is $13,000 and he has $112,000 in his retirement plan. At work he has $25,000 in basic group term life insurance and another $100,000 in group supplemental term life insurance. He also owns a $100,000 term policy.

How much life insurance does John need:

  • Funeral expenses: John needs $10,000 in life insurance for funeral expenses now. But like most people, John doesn't think he will die now. He is 45 years away from 80 years old which is 4.5 decades from now. 4.5 times $10,000 is $45,000. The beginning $10,000 plus $45,000 makes $55,000 for funeral expenses.
  • Pay off his mortgage: Add another $125,000 for his mortgage so John's total is now $180,000.
  • Pay off his debt: John's total debt is $27,000 plus $12,000 or $39,000. His new total is $219,000.
  • Provide for college: John has two kids. Two kids times $100,000 for each child is $200,000. Add this to his prior total and his life insurance needed is $419,000.
  • Income replacement: John decides he wants an ongoing income of $85,000 per year. $85,000 divided by 4 percent is $2,125,000. John can't really fathom that number so he opts instead to replace his income for 5 years. 5 years times $85,000 is $425,000. Added to his prior total and his new total is $844,000.
  • Subtract cash and insurance in force: John has $125,000 saved up and another $225,000 in life insurance in force. That total is $350,000. Subtract that from the life insurance number we calculated he needed in the last step which was $844,000. His new total is $619,000.

Based on the simple 6 steps we calculated that John might want to pick up another $619,000 in life insurance.


In the end, there is no right or wrong answer but the above 6 simple steps will give you a really good foundation for the amount of life insurance you might need.

How much life insurance do you need? How did you calculate it?

Let me know in the comments.

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Michael is a champion of guaranteed issue for employees in the workplace. He's been an insurance agent since 1992 and has worked with thousands of employees.