Life insurance has garnered a reputation for being difficult to understand. Terms like whole life, portability and riders can be confusing, but some people get tripped up by a more basic question: How much life insurance do I need?
"Historically, life insurance has been an intimidating product to purchase," says Brittney Burgett, marketing and communications director for online life insurance agency Haven Life. However, there are a number of tools and resources available to help consumers select the right policy.
For instance, there are three ways to determine the right death benefit, and they range from simple rules of thumb to professional consultations. Regardless of how you determine how much life insurance to buy, remember that your needs will change over time. Plus, you'll need to determine whether you want term life, insurance for a fixed period of time, or whole life insurance, which includes an investment component and can gradually build cash value.
Read on to learn more about how to calculate how much life insurance to buy, understand different types of policies and get the best price.
How to Determine How Much Life Insurance to Buy
You might already have life insurance through your employer. It's a common benefit, and workers may be tempted to assume they don't need a separate individual policy. While some employers offer voluntary life insurance for workers who want to buy greater coverage than is offered through their benefits packages, these packages have pros and cons. Keep in mind group insurance policies may have lower premiums than individual policies. Still, the policies often aren't portable, which means you can lose your coverage if you leave your job.
"They may stop there and think it must be enough," says Tara Reynolds, corporate vice president of marketing and client acquisition for insurer MassMutual. "In most cases, it's not sufficient."
With that in mind, use one of the following methods to determine how much life insurance coverage you need.
Try a tried-and-true rule of thumb. The simplest way to determine the amount of financial coverage you will need from life insurance as a policyholder is to buy a life insurance policy that's equal to a certain multiple of your income, such as five, seven or 10 times your annual salary. Those with significant assets can use a lower multiple, while those with no savings may be better off with life insurance equal to 10 times their salary. Another rule of thumb is to start with a multiple of your income and then add your household debt, or $100,000 per child, to reach an appropriate death benefit.
"Often times, clients come in and we'll use that as a starting point," says Silvia Tergas, financial planner with advisory firm Prudential Financial in Bethesda, Maryland. However, she notes this method doesn't work for stay-at-home parents who may not have an income but still need life insurance to pay for child care and other services they provide a family.
Use an online calculator. Aside from using a rule of thumb to determine the amount of income you'll need, use an online calculator. "Why just stick with a rule of thumb when you can fact-check that with a calculator?" Burgett asks.
Many insurers, including MassMutual and Haven Life, provide life insurance calculators that are free to use on their websites. After filling in a few details, such as any debt, expected college plans and children to provide a more exact figure for life insurance needs, you can get an estimation of how much life insurance you may need.
Seek advice from a professional financial advisor. To best determine how much life insurance you will need, talk to a professional advisor. "As a financial planner, I'm always focused on personal solutions," Tergas says.
An advisor can take a holistic look at your finances, available resources and family goals before making a personalized recommendation for life insurance. If you don't already have a financial planner, look for a financial advisor who isn't limited to selling insurance for a single company. Professionals who charge a fee for their service, rather than taking a commission from the sale, may provide a more objective recommendation.
An advisor can also steer you toward a reputable company, or you can search for a company that is highly rated by the Better Business Bureau or financial data firm A.M. Best. By using one of the three steps above, you can determine the appropriate death benefit and avoid paying for coverage you don't need.
Recalculate Your Needs After Major Life Events
Determining how much life insurance you will need is something you will have to reassess more than once. How much insurance you need in your 20s may be significantly different than what you might need in your 50s.
Experts suggest recalculating your needs after every major life event, such as a marriage, divorce, birth of a child or death in the family. Pregnant women who need coverage may want to apply for life insurance as soon as possible since complications later in pregnancy, such as preeclampsia or gestational diabetes, could affect someone's eligibility or premiums. If you already have a policy and need additional coverage, buy a second plan instead of replacing an existing one. A secondary, smaller policy may be cheaper, and having multiple policies can make it simple to reduce coverage if your need for life insurance decreases in the future. And after a major life event, double-check to make sure you don't need to update your beneficiaries along with your coverage amount.
To make the process easier, Tergas suggests her clients stop thinking about life insurance in financial terms. "Forget the terminology," she says. "Think for a moment that you've left this earth. What do you want to make happen for your family?"
That could be paying off the mortgage for a spouse, covering the cost of college for kids or providing enough income that a surviving parent doesn't have to return to work.
Once you know your answer, add up the amount of money it would take to make those things a reality and use that as your life insurance death benefit. After all, taking care of your loved one's needs and goals is the whole point of buying life insurance in the first place.
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