Unpredictable markets are rough on retirement planning. They also complicate the issue of how much life insurance is right for you. Standard rules of thumb — such as buying coverage equal to eight times your annual income — aren’t always appropriate, and while they can be helpful, online calculators will sometimes tell you to raise your coverage by $1 million even if you already have insurance.
The truth is, many factors influence how much life insurance you need. From how much your family depends on your income to whether or not you need life insurance to cover other expenses like your kids' college education or your final expenses, different factors can dramatically impact how much life insurance you need.
Instead of just aiming for a higher number than you think you need, take the time to do some math and figure out how much coverage is enough to secure your family's financial future. Here's how to figure out how much is right for you so you don't end up overpaying for too much coverage or undercalculating how much your life insurance beneficiary needs.
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How much life insurance do you need?
Overall, life insurance is a personal affair. Two couples may earn equal salaries, but it’s silly to say that someone with four young children should have the same coverage as empty nesters with no mortgage and a substantial retirement fund. Additionally, you’ll likely experience life events that call for changes in your insurance: marriage, parenthood, homeownership, college expenses and retirement.
Instead of relying on rules of thumb, you’re better off taking a systematic approach to figuring out your life insurance needs. That’s easier than it sounds, as you’ll see from the following process because it "truly is an art as well as a science," says Tim Maurer, a financial planner in Charleston, S.C., and coauthor of The Financial Crossroads. Here's what you need to know.
How to calculate how much life insurance you need
The purpose of life insurance is to financially protect your loved ones after you pass away. For instance, life insurance can guarantee your family can live normally in your absence, paying bills as before. For this reason, some experts and most online calculators sponsored by the insurance industry seek to figure out the chunk of investment capital it would take to replace all of your income for 20 years or longer, held securely in treasuries or municipal bonds and certificates of deposit.
However, this approach can aim high, especially if you assume raises and promotions. "You can find people who are extremely minimalist with insurance recommendations," says Maurer. "But I see an overabundance of people who end up justifying more insurance than I think is reasonable."
Instead, he offers a strategy to calculate how much coverage to buy and to form a plan that’s easy to update. The idea is to assess whether you need extra coverage or different policies only after you project your life insurance needs as the sum of the following four categories.
1. Final expenses
The first category is your final expenses. A funeral and related expenses average $6,280 for cremation or $8,300 for burial, according to the National Funeral Directors Association. But the actual cost can vary widely as details like the type of grave marker or the casket chosen can dramatically influence the final price. Additional expenses like meal catering or travel and accommodations for loved ones attending the funeral from out of state can also bring that cost up further.
Your beneficiaries may be able to get the tax-free proceeds from insurance faster than if they waited for money from your estate. Use $15,000 as a ballpark number. But you can also pre-plan your funeral to get a better estimate of how much coverage you'd need here. Funeral planning can also prevent further grief by taking the burden of those logistical decisions off of your family.
2. Mortgages and other debts
Total your mortgage balance, car loans, student loans and any other debts that would be a heavy burden on your survivors. They may choose not to retire the mortgage, especially if the interest rate is low, but the money should be available so that they won’t face the prospect of being forced to sell.
3. Education expenses
This calculation can be tricky because you need to consider the cost of college at the time your kids enroll. For instance, the average cost of tuition at public 4-year institutions increased 20.8% from 2012 to 2023. For private institutions or out-of-state students, tuition rates are rising even faster.
Maurer recommends looking up current costs for the colleges you’re considering, deciding whether you want the insurance to cover all or a portion of the tab, and adding the amount in today’s dollars to your life insurance calculation.
4. Income replacement
Once you cover funeral expenses, debts and education, your family may not need to replace 100% of your income — and that’s where the hard part of the calculation comes in. Maurer recommends covering 50% of current pretax earnings until retirement.
You can translate this into a target lump-sum benefit by dividing it by 0.05. For example, if you earn $100,000, divide $50,000 by 0.05, which works out to $1 million. That assumes the insurance benefits will earn 5% a year over the long haul, a conservative back-of-the-envelope figure.
Calculating your total coverage needs
dd all four categories to estimate how much life insurance is appropriate, then tweak the number to reflect personal circumstances. You might increase it if you don’t have a pension, but you could decrease your coverage if your spouse earns a substantial salary.
If you or a family member has a troublesome medical history, add $100,000 or even $250,000. If you’re the one with the medical condition, you’ll find it tough to buy additional coverage later at a price you can afford.
For most families, this exercise will work out to an amount in the high six figures, possibly even $1 million or more. But don’t be frightened. With term insurance, boosting your death benefit by hundreds of thousands of dollars should cost just a few hundred dollars a year.
Example:
A healthy 40-year-old male nonsmoker might be considering a 20-year, $500,000 term policy for $360 per year. But he could buy $850,000 of coverage for $576, or a $1-million policy for $645, says Byron Udell, owner of AccuQuote, which represents dozens of life insurers.
Women pay less — just $311 per year for $500,000 in coverage and $558 for $1 million. It’s not as easy as it used to be to qualify for the absolute lowest rates.
Other factors to consider when calculating life insurance
While the factors above give you a raw number to start with, your actual coverage needs might be higher or lower depending on a few other factors. Here are some other key things to consider when calculating (or reevaluating) your coverage needs.
Time
How many years will you need life insurance? If you’re in fine physical shape, you can buy a new policy and lock in the price for 20 years.
Some term policies come with the right to convert to a permanent life insurance policy, like whole life insurance. You can keep this type of life insurance for the rest of your life regardless of health. Premiums will be higher than for term life insurance at the beginning, but they usually remain level indefinitely.
The best reason to consider whole life or universal life insurance isn’t the accumulating cash value, although that’s part of the deal. The real issue is whether you’ll need coverage beyond 20 or 30 years — or after age 65 when term gets expensive.
You might want permanent life insurance, for example, if you need to protect kids with special needs who will always rely on you (or your estate) for support, or if you want to leave money to a school, charity or your children and you don’t expect to afford it any other way.
Major life events
Below are several instances when you should seek additional life insurance coverage.
- Getting married: Your new spouse might depend on your income even if he or she earns as much or more than you do.
- Having a child: It takes a lot of money to raise a child — and it doesn't get any cheaper if you're not around.
- Buying your dream home: When you settle into your family's forever home, guard against its loss in case tragedy strikes.
- Nearing retirement This means no more life insurance from work. If you die, your spouse could lose out on pension and some Social Security income.
Type of life insurance
Term insurance is popular because many people can afford plenty of it, but it can make sense to combine term and permanent insurance with multiple policies or buy a convertible-term policy and make a series of conversions over the years.
One advantage of a convertible-term policy is that insurers don’t require a new medical exam when you make the conversions. That essentially gives you a pass if you gain weight, develop high blood pressure or even survive a bout with cancer.
Northwestern Mutual provided this example for a 27-year-old man who starts by paying $317 for $500,000 of term insurance, and then gradually converts it to whole life $100,000 at a time. If you shift $100,000 to whole-life at age 28, your annual premium would jump to $1,300.
If you shift another $100,000 at age 31, your premium would rise to $2,600. Your premium would gradually increase whenever you shift money to the whole-life policy, topping out at $7,200 at age 40, for the entire $500,000 of whole-life insurance.
As long as the insurer remains strong and solvent, the policy’s cash value will rise every year, as will the death benefit. By age 65, in this example, the benefit is projected to be $990,000 and the cash value $475,000, which can be borrowed, withdrawn or tapped to keep the policy in force without paying additional premiums.
This kind of flexibility was attractive to Nirmal Bivek, a banker in Atlanta, who bought slightly more than $1 million in life insurance coverage when his 3-year-old daughter, Sarina, was born. Bivek has already converted some of the coverage to whole life and expects to convert more of it as his income grows.
He added more insurance when he and his wife, Vijal, were expecting a second child and when they bought a vacation home. "I’m in good health now and term is cheap," says Bivek, "so I’m buying as much as I can now and converting it over time."
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