Let’s face it: Life insurance is not one of those sexy money topics like investing. Life insurance has gotten a bad rap over the years mainly because it is misunderstood. While life insurance is not for everyone, most of us could benefit from life insurance at some point in our lives.
Life insurance is simple. You purchase a death benefit amount for a specific premium based on your age, health and income for a specific period. If something unfortunate happens to you, a beneficiary of your choice receives the death benefit tax-free in most situations. There are two types of life insurance: term (like renting for a period of time) and permanent (a policy that can stay in force until age 120+ and has a cash value component).
For most of us, term insurance is going to meet our needs. Now that you have a basic understanding of life insurance, you should consider a few questions to help you narrow in on how much life insurance you need.
Payoff and Goals Method
There are lots of different life stages you might go through during your lifetime.
- Graduating college
- Getting married
- Starting a family
- Starting a business
- Buying a house
Each different life stage brings with it new money challenges and opportunities. One of the smartest money moves you can make is to figure out what your life goals are. It is impossible to know the exact trajectory of your life right now, but you start by making a goals list based on what you would like to happen.
Your goals list will help you figure out how much life insurance you need. For instance, maybe you just bought a new house and would like to have enough life insurance to cover your mortgage if something happened to you. There are lots of reasons why you might consider life insurance. Creating a goals list will help you identify what your needs are and how much life insurance you might need to cover your goals.
Eight to 10 Times Income Method
The OG method to figure out how much life insurance you need is to take a multiple of eight to 10 times your income. For example, if you make $50,000, you might consider purchasing between $400,000 and $500,000 of death benefit.
This method is not an exact science, but life insurance carriers are more willing to issue a policy where the death benefit is within a reasonable multiple of your income. Again, one of the underwriting factors for life insurance carriers is the amount of your income.
Replace Your Income Method
One of the most compelling reasons to purchase life insurance is if you are married or in a relationship and you and your significant other rely on each other’s income. After all, earning your paycheck is a very valuable commodity that enables you both to life your lives. The question is: What happens to your daily lifestyle if you suddenly lose one of those paychecks?
No one plans on dying. It is the only given in life; however, we do not like to think it is going to actually happen to us. It makes sense then to ensure that you have enough life insurance to replace your income if something happens to you.
For example, let’s say you earn $50,000 a year. An insurance policy with a $1,000,000 death benefit that is invested and earns on average a 5 percent return would give you $50,000 a year. Enough to cover the lost income. This method is meant to help you gauge the value of each other’s paycheck and think about how you could use life insurance to replace your paycheck.