How to Calculate Coverage Needs
Our life insurance needs calculator provides a quick and easy way to estimate your needs. You can also talk to a Quotacy agent who will conduct a needs analysis with you free of charge.
Below are different methods people use to calculate their life insurance needs.
Life Insurance Rule of Thumb
With this method, you multiply your annual income by 10 to find your coverage amount. By multiplying a provider’s income by 10, a family can theoretically continue to pay typical expenses and maintain the same standard of living for the 10 years following the provider’s death.
Example: You earn $75,000 annually. 75,000 x 10 = 750,000. You apply for a $750,000 life insurance policy.
- Pro: The most basic way to calculate how much life insurance you need.
- Con: It doesn’t account for inflation.
- Con: It doesn’t acknowledge individual circ*mstances, such as age, occupation, children, or debt.
Goals-Based Approach
With this approach, you purchase enough life insurance to cover specific goals. These goals are often your reasons to buy life insurance in the first place.
Example: You have a family and a mortgage. If you die tomorrow, you want your family to remain in their home and provide for your children’s college education.
Remaining mortgage: $200,000
In-state 4-year college tuition and fees: ($11,000 x 4 years) = $44,000 x two children = $88,000
Total life insurance needs to cover goals = $288,000
- Pro: It’s simple and easy to calculate.
- Con: It fails to address many financial needs.
Income Replacement Approach
This method uses human life value, which accounts for after-tax income, inflation, and growth rates. Essentially, this approach says that the amount of life insurance coverage you need equals how much you will earn until you retire.
Example: Your gross annual income is $50,000. You plan on working for 20 more years.
Using a financial calculator with inputs of a 5% return on investments, a 2.9% inflation rate, and 3% income growth, your human life value/life insurance need is $1,042,423.
- Pro: It factors in inflation.
- Con: It doesn’t anticipate family assets, additional income, investments, or Social Security survivor benefits.
- Con: It doesn’t leave room for expenses that occur after the death of a provider (medical, funeral, estate settlement, and debt expenses).
Needs-Based Approach
This approach suggests you first add all your debts, final expenses, and the income you need to replace. It’s assumed that your income covers everyday things such as food, clothing, utility bills, and transportation.
Then, subtract assets your family could access, such as savings, stocks, bonds, mutual funds, and existing coverage, such as group life insurance or voluntary life insurance through your employer.
Example:
Debts and Expenses:
Mortgage = $200,000
Children’s college: $88,000
Credit card debt = $10,000
Funeral expenses = $20,000
Total: $318,000
Annual income:$75,000 (then divide by 4%, which is a conservative interest rate for investments)
Total: $1,875,000
So far, life insurance needs equal $2,193,000 (318,000 + 1,875,000).
Subtract the funds you currently have in savings, investments, and the face amounts of any other life insurance policies you may have.
Assets:
Savings Account = $10,000
CDs = $15,000
Group life insurance = $75,000
401(k) = $80,000
Total: $180,000
Your life insurance needs equal $2,013,000 ($2,193,000 – $180,000).
- Pro: This method provides a relatively accurate life insurance needs analysis. It’s more customized to an individual’s situation.
- Con: It’s time-consuming to calculate.
Term vs Whole Life Insurance Coverage Amounts
Term life insurance is simple, temporary coverage. Whole life insurance is more complex and lasts forever. Each addresses different life insurance needs.
How Much Term Life Insurance Do I Need?
For most individuals and families, term life insurance is the best option because it’s much more affordable than whole life. And most people need life insurance for income replacement and debt repayment, which term life insurance is ideal for.
Term life insurance can be customized according to your needs and financial goals. Coverage can last anywhere from 10-40 years. And coverage amount options range from $50,000 to $65,000,000.
Generally, a longer term is best when you have young children (or don’t yet have them but plan to) and are far from retirement. A shorter term is best when your children are close to college, and you are near retirement.
In some cases, buying more than one term policy makes the most sense and saves you money. This strategy is called laddering.
Laddering life insurance policies can mean buying more than one policy at a time with varying term lengths and coverage amounts, or it can mean owning more than one policy and purchasing them at different intervals.
Answer these three questions to start figuring out how much term life insurance you need:
- Do you have debt? How many years until it’s paid off?
- How much income do you provide annually? How many years do you think it would take for your family to become financially stable after you die?
- How many children do you have? How many years until they’re financially independent?
Term life insurance can often be converted into whole life insurance, allowing policyholders to transition their temporary coverage into a permanent policy without undergoing a new health examination, thereby securing lifelong protection.
Learn more about getting aterm life insurance policy through Quotacy.
How Much Whole Life Insurance Do I Need?
The features of whole life insurance may be attractive to some people. While the premiums are much higher than term life insurance, this policy lasts your entire life and has cash value accumulation. Participating whole life policies even have dividend earning potential.
Using whole life insurance for all your life insurance needs is not cost-effective. For example, your mortgage loan payments won’t last forever. If you have a 30-year $350,000 mortgage loan, buying a $350,000 whole life insurance will be about 10-15 times more expensive than buying a $350,000 term policy with a 30-year term.
Unsure if you need whole life? Consider the following:
- Do you want to provide an inheritance to heirs?
- Do you have a large estate that will be subject to state, federal, or inheritance taxes?
- Do you have a business that requires long-term life insurance needs?
- Are you caring for someone who will be financially dependent on you their entire life?
- Have you maxed out 401K and IRA contributions and are looking to add to your financial portfolio?
If you answered yes to any of these questions, you might need some whole life insurance.
Learn more about getting a whole life insurance policy through Quotacy.
Do I Need Some of Each?
If you have both temporary and permanent insurance needs, think about buying some of each.
Purchase enough term life insurance coverage for your big-ticket financial responsibilities (such as the mortgage and providing for your children from infancy to adulthood). Then, supplement it with a small permanent life insurance policy to cover final expenses and leave some money behind for your loved ones.
Work with Quotacy to Get the Best Policy at the Best Price
If you have a financial planner, this person will help you determine your life insurance needs. They are knowledgeable in the different calculation methods.
However, we don’t all have financial planners. At Quotacy, our life insurance agents can help you determine your life insurance needs at no extra charge.
Everyone deserves financial security. We’ll help you find a life insurance policy that works for you and your loved ones. Get a quote today.
