How much life insurance do I need? I like challenging puzzles, which makes this a great question to ponder.
Unfortunately, the exact answer to this question won’t be clear until the need for insurance is upon us; therefore, we must make a plan today and be ready to adjust that plan as needed.
When considering the right amount of life insurance coverage, I like to begin with the “DIME” method and then expand it with a few more questions to find the maximum needed coverage for each individual. Then, after finding the top amount, I can estimate an appropriate lower amount based on other assumptions.
First, let’s see how the DIME method works. DIME helps estimate the cost of Debt, Income, Mortgage, and Education expenses.
Young people starting out tend to have high college loans in addition to credit cards and other debts. They need new clothes for their new jobs, appliances and furniture for their homes, and reliable vehicles to drive. Before long, they find themselves in debt for tens of thousands of dollars.
When I help people learn to pay down debt, I commonly see $50K and more in non-mortgage debts. Upon death, you won’t want to pass these burdens on to your heirs.
Lost income affects those who remain after we are gone.
People living together share certain economies of scale. For example, adding a second person in the home doesn’t increase the cost of heat or property taxes. However, the home’s costs remain steady when an income producer dies and takes that income with him or her. Because of this, policy buyers should generally provide several years of replacement income through life insurance. While the year number can vary, ten years of replacement income is a good estimate.
The good news is that life insurance proceeds are generally not taxable as income. So, for example, if you normally spend 30% of your income in taxes, you can replace your spendable income with only 70% insurance coverage.
Many employers offer 1-2 years of income protection through group insurance. This benefit is wonderful as long as you maintain your employment. However, it doesn’t go with you when you and your employer part ways. A personal insurance policy is a better plan because it follows you wherever you go. In addition, the policy is under your control and not under the decision-making power of your employer.
A mortgage is usually a family’s largest expense. Reducing or eliminating this expense greatly eases financial stress and reduces the need for income. One should always consider the mortgage when estimating for life insurance coverage. Paying off a mortgage eliminates income needed to pay interest on the loan.
Education costs keep rising, and the cost of four years of residential college can easily exceed $100,000 per child. Students can receive scholarships and work to pay down their bills, offsetting the cost of college and providing an education in the reality of life; but most parents want to also provide some help with college expenses for their children. Prior knowledge of the exact amount of money needed is impossible, but planning to provide, say, $50,000 or $75,000 toward an education is a reasonable safety net to purchase through insurance.
Let’s consider two more topics: ELDERCARE and LEGACY GIVING.
The Social Security system is straining to accommodate more beneficiaries with funds from fewer contributors. I enjoy helping people plan to save, so they do not have to rely solely (or at all) on Social Security. I also believe that we need to consider eldercare as we discuss life insurance because we will want to provide our parents with help if we are not alive to do it ourselves. I understand that most people would not be able to personally care for their aging parents, but in case you are unable to help them, who will? If the breadwinner in your family passes before you and your parents, will you have enough money to spend meaningful time with your parents?