Okay, so you’ve decided to get life insurance. Good call! The next question is, how much is enough life insurance?
This is one of the big, important questions. Too much life insurance, and you’re paying a bit more each month than you need to. No biggie, but still, no one wants to waste their hard-earned cash. Too little life insurance coverage, on the other hand, could leave your loved ones in a financial pickle.
But don’t worry. You don’t need to be a rocket scientist to calculate the amount of life insurance you need.
A few things to consider at first
First, the basic things to ask: Who do you want to provide for with your life insurance policy? What costs are you looking to cover, and how long will you need to cover them? What existing assets and resources do you currently have that can help to pay those expenses?
Lemonade offers no medical exam term life insurance, which lasts for a specific amount of time (the ‘term’) and then expires.
In all the discussion that follows, we’re assuming you want to provide for your family’s needs if you were to pass unexpectedly—mortgage costs or college tuition, or to pay for your own funeral costs, aka ‘final expenses.’ We’re assuming, if you don’t pass prematurely, you’ll have time to work, save, and contribute toward all those sorts of current and future expenses.
To figure out your loved ones’ financial obligations, you’ll need basic figures like expenses and assets, and a rough idea of what those will be over a number of years into the future.
Once you determine your costs and subtract your savings, you’ll have what’s often referred to as your coverage gap. That’s a good starting point for how much insurance coverage you’ll need, aka the ‘death benefit’ you’ll want to choose for your policy.
Calculating your coverage needs
With the caveat in mind that everyone’s situation is different, the most commonly used rule of thumb that insurance nerds like us suggest is to buy a policy with a payout (‘death benefit’) that’s 10 to 15 times your own annual salary.
So, obviously <whips out calculator>, if you’re making $50,000, that would be a $500,000 or $750,000 death benefit, which sounds like a handsome amount to help your family should anything happen to you.
Still, what seems like a windfall can go quick. If you have children and want to provide for all the opportunities that a college education affords, you may want to factor in tuition and other expenses—let’s call that $100,000 per kid.
And forget your offspring’s future college costs for the moment. You might want to consider any money you still owe for your education.
For many Americans today, the elephant in the room is student loans. Keep in mind that if anyone co-signed your loans, be it your parents or your spouse, they may be on the hook for the payments if you should pass away unexpectedly before they’re paid off. The last thing you want is for your grieving family to find that you didn’t account for that cost when you calculated your insurance needs.
How to get an affordable life insurance policy
There are several factors that affect how much you’ll be paying to get the life insurance coverage you need.
One of the most significant factors that impacts your insurance premium payments is the type of life insurance you choose. There are dozens of different types of life insurance products on the market today, but the most common types you’re likely to see are term life insurance and whole life insurance.
Term life insurance covers you for a set period of time. For example, Lemonade offers term lengths of 10, 15, 20, 25, and 30 years. If you were to pass away within your selected term, and the claim is approved, your beneficiaries would receive a death benefit payout. But, in the likely event that your policy expires and you’re still alive (woohoo!), the life insurance company does not payout any benefit, and you’re free to apply for a new policy. Because there’s often no death benefit payout in term life policies, the insurer can offer lower premiums. Lemonade, for example, offers monthly premiums as low as $9/mo, if approved.
Whole life insurance on the other hand, is a different story. Whole life is a type of permanent life insurance, and is exactly that—permanent. The coverage lasts as long as the policyholder lives (assuming they stay on top of their premium payments, of course). With whole life insurance, there’s essentially a guaranteed death benefit payout when the policyholder dies, whether that’s in 5 or 50 years. Because there’s a high likelihood that the insurance company will have to payout eventually, premiums for whole life policies can be between 10 to 15 times higher than those for term life insurance .
Other factors that can affect the cost of a life insurance policy are: the coverage amount, the term length (in the case of term life insurance), and the policyholder’s age and medical history.
What if I already have life insurance through my job?
Now, you might be saying, “Hey! I already have a life insurance policy thanks to my employer, so I don’t actually need any of this stuff!” Not so fast.
If you have a group life insurance policy through your work, it’s not a bad perk. But consider it a cute little moped compared to the Cadillac of a term-life policy that might have a $1 million payout. The death benefit of your employer-provided life insurance is likely only about one or two times your annual gross salary. That’s a nice chunk of change, but it won’t keep your surviving loved ones afloat indefinitely.
And, while this may seem obvious, group life insurance doesn’t go with you if you leave or lose your job. It might make sense, as a result, to keep any employer-provided policy out of your equations… but it’s up to you.
Anticipate what the future might bring
Let’s say you’re single at the moment, and you’re not sure you see little ones in your future. But who knows? Swipe right on the right person tomorrow and all that could change. (Good luck, we’re rooting for you!)
A few extra dollars a month could help provide financial protection for any potential life partner, spouse, or children down the line. And remember, term life insurance rates tend to get more expensive as you get older. So the earlier you buy, the better the rate you lock in.
If you do already have someone in mind that you need to cover, especially if it’s your spouse, talk to them about how they would want to use the money and what needs they foresee that you might not have thought of. Talking about death is nobody’s idea of a good time, but it’s important, and the conclusions you arrive at together may affect the size of the policy you feel you need.
Can we get down to some numbers?
There’s no easier way to see how this all plays out than to walk through a real-world example.
We’re going to wade deep into some numbers here, but don’t be scared—we’ll try to keep the math as painless as possible.
If you’re in a rush, here’s the TL;DR version…
The goal of your term life policy is to ensure that your loved ones have a financial cushion if you weren’t around to provide for them any longer.
Ask yourself what your family’s expenses are for an average year. What do you pay in rent, or toward a mortgage? Do you still have student loan debt? What’s your own current income, and what would your loved ones need to offset this if you were no longer around to contribute financially?
Then think of your available resources and assets, which could balance out some of those costs. That includes any savings you currently have in the bank, as well as the value of things you might own outright (like your home, if you’re lucky).
Based on those personal calculations, you’ll want to make sure that your term life plan’s payout (aka death benefit) is sufficient for your needs. This will be different for everyone. If you’re a 31-year old mom buying a 10-year term life policy, you’re basically posing a hypothetical question to yourself: “If I were to pass away at the age of 40, what amount of money would safely cover my family from that point into the future?”
How about an example?
Meet Jennifer and Muhammad, proud parents of an adorable two-year-old. In order to buy a life insurance policy that will carry them through to when their child has snagged her diplomas, they opt for a term life insurance policy with a term of 20 years.
How much life insurance coverage will they need (in other words, what ‘death benefit’ should they aim for)?
Well, we have to take a close look at both Jennifer and Muhammad’s assets and liabilities.
- Jennifer earns an annual income of $50,000, and Muhammad makes $60,000.
- Jennifer has group life insurance through her employer with coverage equal to one year of her salary. Muhammad has no life insurance through his job.
- Their joint savings account currently holds $60,000.
Liabilities and expenses:
- $50,000 outstanding on their home loan.
- $2,500 in credit card debt.
- $15,000 of student loan debt.
How much coverage would Jen and Muhammad need?
It’d be nice if there were a simple machine that could chew on all these numbers and figures and give a definitive answer. But every case is different, and the coverage you’ll need (or that our pal Jen will need) really depends on individual circumstances.
If we go with the rule of thumb we mentioned earlier—multiplying Jen’s annual salary by 10x or 15x—we’d arrive at a need for between $500,000 and $750,000 in coverage. That’s a good starting point for a conversation…
From there, Jen and Muhammad would want to dig into the particulars of their situation. While they have $60,000 in the bank, they also have $67,500 in outstanding debt. Oof. Jen does have that group life insurance plan with a payout of $50,000, but that disappears if she loses or changes her current job…so we’re not going to factor that in here.
If Jen were to pass away in ten years, when their daughter is 12, would they require any form of childcare so that Muhammad is able to work full-time?
Are they possibly going to have a second child in the next few years? (Let’s say that on average the expenses to care for a child run to around $15,000 a year… with the cost of college adding another $100,000 to those calculations.)
Once Jen adds in other considerations—like $7,500 to provide for funeral costs, for instance—it’s possible that she might decide that $1 million in coverage is the best fit for her family.
That sounds like a lot… and indeed, a tax-free windfall of a million dollars right now would probably seem extravagant! But keep in mind that this is the funds that her loved ones will depend on to carry them well into the future, if she’s not in the picture as a financial provider.
We wish Jennifer and Muhammad a long and happy marriage! But if something unfortunate happens to Jen along the way, she’ll know that she’s accurately provided for her surviving loved ones.
So, now you know a bit more about how to figure out how much life insurance you need. You’re that much closer to peace of mind. With that number in mind, you’re ready to start a Lemonade term life insurance quote—your future self will thank you.
Hey, we don’t want to forget our boilerplate legalese! Everything you’ve just read is for educational and informational purposes only. It is not to be used as a substitute for competent insurance, legal, or tax advice from a licensed professional.