How Much Life Insurance Do I Need?

If you are considering getting life insurance, one of the first questions on your mind is: “How much life insurance do I need?”

Let’s be frank – one of the reasons why people usually hesitate to buy life insurance is how expensive they think the rates are. However, what if we told you, that may not necessarily be the case? 

An image of a golden piggy bank with stacks of money next to it.

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In today’s topic, we’ll cover:

  • How to determine how much life insurance you should get and how to calculate it?
  • What are some of the factors you should take into account? 
  • And finally, what is lifestyle banking, and how can it change your life?

Do we have your attention? Good, let’s get started!

How to Calculate How Much Life Insurance Do I Need?

When buying life insurance, you may pay lower or higher premium rates, depending on many factors, circumstances, and even your financial needs.

But most experts agree that there are some notable factors when choosing life insurance to take into account, like:

  1. Age
  2. The ages of your loved ones (like significant others and children)
  3. Current income
  4. Home mortgage and other debts
  5. College costs for your children or spouse
  6. The bill for final expenses, i.e., funeral expenses. 

Now, this is where it gets a bit tricky. There are different ways to calculate how much life insurance you need.

If you want to calculate it manually, you can use this formula: 

“[Financial obligations you want to cover] – [existing assets that can be used toward bills] = Your life insurance need.”

First, you need to determine what your financial obligations are. The best way to determine this is to add up:

  • Your annual salary and then multiply it by the number of years you want to replace that income.
  • Your mortgage balance.
  • Any other debts.
  • Any future needs such as college fees and funeral costs.
  • If applicable, the cost to replace services that a stay-at-home parent provides, such as child care.

Once you add it all up, subtract all liquid assets like savings, existing college funds, and even additional life insurance policies. The final result should be the amount of how much life insurance you need. It seems a bit complicated, right?

Luckily for you, there is easier to determine how much to pay for premium rates. Like using a Life Insurance Calculator!

How Does a Life Insurance Calculator Work?

Now, a short disclaimer – there are a lot of different life insurance calculators out there. But for this article, we will use this one from Prudential Financials for individuals. 

A screenshoot of a life insurance calculator with blank fields.

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Let’s use an example. You are a man, age 35, with an annual income of $72,000. You are also married with two children, ages 6 and 2. Recently, you’ve started thinking of buying life insurance policies, just in case something happens to you. 

The first thing you need to do to calculate how much life insurance to get is to fill in/select the necessary information:

  • Your age
  • Your gender
  • Your relationship status
  • Number of children
  • Age of your youngest child
  • Your annual salary
An image of a life insurance calculator with necessary information filled out.

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Once you enter your information, click on calculate. You’ll get an estimate of your life insurance needs in just a few seconds. In your case, your needs should amount to $1,131,000.

An image of a calculator showing how much life insurance you need.

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Keep in mind that this calculator only provides you with an estimate of how much coverage to get. It also doesn’t take into account any other savings, existing life insurance, or contributions of a stay-at-home parent. If you want to check if this holds up, consult a certified financial planner.

Other Methods for Calculating Life Insurance

So what are some other methods to calculate – or estimate- your life insurance?

There are several methods to choose from, but these next ones stand out the most. 

The first method is the human life value, which is based on the value of your current and future earnings. The simplest way to estimate this is to get:

  • 30X your income if you are between 18 and 40 years of age;
  • 20X if you are between 41 and 50 years of age;
  • 15X if you are between 51 and 60 years of age and;
  • 10X if you are between 61 and 65 years of age.

If you are above 65, your life insurance coverage will be based on your net worth. 

Now, if you’ve been looking for advice online, one of the most shared guidelines for estimating your life insurance needs is multiplying your income by 10. Though, the number can vary – some say to multiply your income by 5, others by 17. We don’t recommend this method, as it doesn’t consider all of your financial obligations, such as savings, debts, future expenses, or even your and your family’s needs.

Another variation of this formula mentioned above is to account for ten times your income plus $100,000/$150,000 per child for college expenses. Which, in a way, makes more sense. After all, college tuition can be expensive, and there are many people with substantial student loan debt. And the more children you have, the bigger the expenses are. While this method is simple, it still doesn’t account for other costs, assets, or unique situations. 

What is the DIME Method?

A visual representation of the DIME method.

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But the most comprehensive formula on this list is the DIME formula. It stands for debt, income, mortgage, and education. As the name suggests, this formula takes a more detailed look into your finances by accounting for the four major areas for calculating life insurance needs. 

  1. Debt is how much obligation you have, excluding your mortgage. This includes student loans, credit card debt, car loans, funeral expenses, and even money you’ve borrowed from family members or friends. 
  2. Income helps you determine how many years your family would need support and then multiply your annual income by that number.
  3. The mortgage is pretty self-explanatory. You add your leftover mortgage payments to the equation. 
  4. Education factors in the anticipated college tuition for each of your children, which is about between $100,000 and $150,000 per child.

Adding all of these factors together gives you a much more well-rounded view of your needs. However, if you have any current savings and existing life insurance you already carry, you will need to subtract them from the final amount. Otherwise, you might be it could leave you over-insured. This formula also fails to the unpaid contributions of stay-at-home parents, so you might want to keep that in mind. 

While all these methods can be useful, remember that they provide an estimate of your life insurance needs, which may or may not be so detailed. To better represent your needs, use a life insurance calculator and get advice from a financial professional.

Understanding the Terminology

Like many legal documents, life insurance policies often use terms that can get very confusing. Here is what you need to know:

  • Beneficiaries are the people who will receive the money after you pass away, like your surviving spouse, children, parents, or anyone else you name. 
  • The death benefit is the total amount of money your beneficiaries will receive after your death. You can choose the face value, so it may not always be a fixed amount.
  • The insured is the person covered under the insurance, or in this case – you.  
  • The insurer is the company that provides coverage.
  • Premiums are the payments you make to the life insurance companies.
  •  Riders are optional coverage or features you can add to your life insurance anytime. You can add your child as a beneficiary or add-ons like an accidental death benefit. 

Term vs. Whole Life Insurance – What’s the Difference?

What Is Term Life Insurance?

Term life insurance, also known as pure life insurance, is a type of insurance that covers you for a period chosen at purchase. Hence the name – term life insurance policy.

It can last you 10, 20, or 30 years. If you die during a specified term, the policy will pay your beneficiaries a fixed death benefit. But no one gets the benefit if you don’t die during that time. In case the term expires, you can:

  •  renew the policy for another term, but you may have to pay higher rates each year,
  •  cancel it, 
  • or convert it to permanent life insurance. 

Many people go for a term life insurance policy as it can help you:

  • Pay off any large debts you have, like mortgages.
  • Make sure your children have a college fund.
  • Replace your income if you die during your working years and are the sole breadwinner for your family. 

Please bear in mind that we never advise you to buy term life insurance, and you’ll soon learn why.

What Is Whole Life Insurance?

As you can tell by the name, this type of insurance lasts your entire life. You don’t have to worry about your policy expiring and losing payouts. Well, as long as you keep paying your life insurance premiums and follow the carrier’s requirements, of course.

Although you may have to pay higher premiums than term policies, they are fixed. Their rate doesn’t change. However, you’ll still want to consider your other final expenses, like funeral costs or any future plans you might have. Your insurance needs may change over time. 

This type of permanent life insurance is great because some policies even offer an investment component, which can help you build cash value. You can take the fixed premiums and invest them into the market. Over time, you can even have enough to leave an inheritance. 

What Are the Key Differences Between Term and Whole Life Insurance?

Many people choose term life insurance as it offers large payouts at a lower cost than whole life at lower rates. For example, let’s say you are a healthy 30-year-old woman, purchasing life insurance of $500.000. If you go with an overfunded life coverage amount, you may have to pay around $4.143, but if you choose a 20-year term policy, the average cost will be $190. Quite the difference, right? 

However, keep in mind that term life insurance has an end date. So each time you renew your life insurance coverage, the term policy’s premiums may increase each time. Also, to build financial independence with term policies, you must jump through many hoops and obstacles.

Meanwhile, whole-life premium rates are fixed, as the policy doesn’t have an end date. And as long you regularly pay premiums,  you can use overfunded life insurance as a way to supplement your annual income and build a safety net for you and your loved ones.

To summarize this section here is a helpful table that compares these types of life insurance. 

A table showing how much coverage you can expect from each insurance type.

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Are You Familiar With Overfunded Life Insurance?

One of the main reasons people avoid getting a life insurance policy is that it can put a dent in finances, which is understandable. 

But, what if we could tell you there is a way to build wealth and gain financial independence with the help of your life insurance policy? 

If you’ve been researching life insurance, chances are, you’ve come across something called infinite banking. Also known as lifestyle banking, it is personal financial support that relies on using a whole life insurance policy as a “personal bank.”

Why implement overfunded life insurance? Because overfunded policy creates an investment component. If you make regular payments, you can accumulate money to your policy over time. And the longer you hold the policy, the more wealth you build. Every time you overpay your premium, you’re increasing the cash value. 

But here’s the best part – after you make a sufficient amount, you can borrow money from your overfunded life insurance. Via policy loans or cash withdrawals, you can use money from your policy without having to worry about limits, interest charges, loan agreements, or other bank-related fees. 

So if you’ve been looking for a way to improve your finances or add to your retirement savings, why not become your own bank?

Why Should I Consider Lifestyle Banking?

So let’s discuss some ways to use infinite banking to your advantage.

If your goal is to start your own business, it might be a good idea to use lifestyle banking or cash value from your insurance policies for a head start. When you borrow money from a bank, you need to pay the borrowed money back to the third-party lenders with interest. And interest can be pretty high, especially if you are using it for your business. 

But when you borrow funds from your policy, it returns to you. So, use the funds from your policies to cover startup costs, pay for business equipment, settle your taxes, or even lend money to your business or businesses without limits or high interests. 

You can also use lifestyle banking as another means to help you and your family improve the quality of your life. 

  • Want to buy a new car or a home? Borrow from your insurance policy. 
  • Burdened with medical expenses that aren’t covered by your health insurance? Take a loan from yourself. 
  • Need money for home repairs or want to remodel your kitchen? Get the money for it from your policy. 
  • Have a debt or student loans hanging over you? Use the money from your “personal bank” to settle it. 

No matter what you use the money from your policy, you can always accumulate your wealth back. As long as you make regular premium payments plus interest, you rest comfortably knowing your policy has got you covered!

Final Thoughts

So what are the main takeaways from this article? 

  1. There are different kinds of life insurance to choose from. 
  2. How much life insurance you need depends on your needs and life goals.
  3. There are many ways to estimate how much life insurance to get.
  4. If you want to accumulate wealth and better your financial situation, then over-funded life insurance might just be the answer you’ve been looking for. 

However, we’ve only scratched the surface when it comes to lifestyle banking.