When it comes to life insurance, there's no lack of quick-fix formulas. Some experts suggest purchasing enough to cover 5 to 10 times your annual income—but that's a big range. The problem with formulas is that they’re only general guesses, and life insurance is personal. Calculating your annual income is a fine place to start, but you also need to take into account your savings, Social Security, childcare and tuition costs, or special circumstances such as pending or future medical bills.
While you can’t pinpoint exactly how much life insurance you’ll need to purchase down to the nickel, if you use a strategy that takes into account your current financial situation and future needs, you can make an informed estimate. Take into account the following factors to ensure that the amount of life insurance you purchase is based on more than just a guess.
- End-of-life expenses. No one likes to think about this one, but it’s necessary to estimate funeral, burial and other final expenses that will need to be paid when you pass. While prices can vary, the average cost for a funeral and burial in the United States is between $7,000 and $10,000.* At the very least, a life insurance policy should cover these expenses.
- Outstanding debt. The last thing you want to leave your grieving loved ones is a big pile of debt. It’s important to take into account your mortgage, credit card debt, car loans and other loans when determining life insurance needs. You should also factor in the interest that those loans will accumulate.
- Education costs. If you don’t have children, you can skip this one. If you do have kids, you’ll want to be sure their educational expenses are taken care of after you’re gone. Figuring out future college expenses can be tricky. A simple way to calculate what the cost of tuition will be when your child is ready to enroll is to take the current cost of the school your child is to attend and add 5 percent per year (the average annual increase in college tuition).
- Income replacement. This is a big one. To figure out how much income you’ll need to replace, take your current annual income and multiply it by the number of years your family would need support. This could be the number of years before your youngest child goes to college. Once you have this number, you’ll need to add some extra cushion to guard against inflation.
- Social Security benefits and savings. Survivor benefits from Social Security can be substantial. Exactly how much your family will receive depends on your average lifetime earnings. Visit the Social Security Administration for more information on survivor benefits. In addition to Social Security benefits, don’t forget to add up assets such as 401(k)s, IRAs and emergency savings. Generally, the more assets you have, the less life insurance you’ll need.
Calculating your life insurance needs isn’t always easy, but it doesn’t have to be a shot in the dark. An educated estimate based on your real-life circumstances can get you closer to the actual amount your family will need. Learn more about life insurance and find the best option for you and your family based on your long-term goals.