After learning about the different types of life insurance, the next question is always, “How much life insurance do I need?” If you read our previous blog, you’re probably asking yourself that question right now! There’s a lot to consider when calculating the amount of life insurance coverage that’s right for you, so let’s get into it.
How to Calculate Your Life Insurance Needs
The DIME Formula
Calculating how much life insurance coverage to buy is an essential part of financial planning. The DIME formula is an easy rule of thumb you can use for just that. It won’t provide you with an exact amount, but it will get you in the right neighborhood. Broken down, this stands for Debts+Income+Mortgage+Education. Let’s go through step-by-step to see how it works!
Before deciding on an amount of life insurance to purchase, you’ll need to add together your existing long-term financial commitments. This includes car loans, credit card payments, and even student loans.
For our example, let’s assume that we have the following debts:
- Car Loan – $5,000
- Student Loan – $20,000
- Credit Cards – $5,000
Adding those together, we get $30,000.
If your family is supported by your income, this is an essential step. By adding your annual income to our formula, we ensure that your family can continue to afford the living expenses covered by your salary. Obviously, insurance can’t provide the same level indefinitely, so try to think of the number of years you’d like to have your policy cover. For example, it is well within reason to provide an income for your children until they are old enough to become financially independent.
If your spouse works and you depend on their income, include it as well. Add their annual salary to yours and multiply that by the number of years you think you’ll need to provide supplemental income for your family.
For our example, let’s say we have a single source of income that is $80,000 a year and we’d like to provide that for 10 years. That comes out to $800,000.
A house is more than just a building; it’s your family’s home. Too often surviving family members are forced to move out of their home after the death of a loved one due to financial constraints. For this step, find out how much is left on your mortgage and add it to the running total. By adding this amount, you’re ensuring that your family won’t have to leave their home should something happen to you.
In our example, we’ll say we have $150,000 remaining.
If you have children or plan on having children, you need to consider their futures, too. As you’ve probably learned, a college education isn’t cheap. The average annual cost for public in-state college is around $25,000. For the final portion of our DIME example, let’s say we have a single child. Using that average, we can estimate a cost of $100,000 to send our hypothetical kiddo through a 4-year university.
Adding it All Together
By adding together your debts, income, mortgage, and cost of education, you will finally arrive at your estimated coverage amount. Let’s review the figures from our example:
- Debt – $30,000
- Income Estimation – $800,000
- Mortgage – $150,000
- Education – $100,000
This brings our total estimated coverage to $1,080,000. Simple, right?
While the DIME formula is an easy way to ballpark your coverage, the reality might be a little more in-depth. In addition to the factors outlined in the previous formula, you’ll want to think about your funeral expenses and what cost that may add to your final expenses. If you have a substantial inheritance to pass on, you may also want to consider the cost of the estate tax.
If you have any assets, such as savings accounts or investments, these may actually reduce the amount of coverage you need. You may consider your retirement savings as well, but these are usually counted separately depending on the type. Many retirement plans impose heavy penalties if you cash out early.
Finally, it isn’t uncommon for people to have multiple policies with other life insurance companies. If that’s you, make sure to factor the death benefit from that policy into your total.
If you’d like an alternative to the DIME formula, it’s easy to find an insurance calculator online. They ask a series of questions about your assets and debts and attempt to estimate the amount of coverage you need. These can be helpful when you’re researching various insurance companies and policies. However, like the DIME formula, it is important to keep in mind that these are only estimates. To find an exact number, it’s best to consult your financial planner and contact a life insurance agent.
Get a Quote
Now that you have an idea of the amount of life insurance coverage you’ll need, you’ll probably want to get a quote!
Your quote will depend on a variety of factors, such as your choice to go with term life insurance or whole life insurance. As discussed in our previous blog, term coverage usually has a lower premium for a higher amount when compared to whole life policies. However, every situation is different and it is always best to speak with a life insurance agent to weigh your options.
It’s time to move to the final stage of buying life insurance: the application. But what happens if you’re denied? In our next and final life insurance blog, we’ll explain what goes into the application process and what steps to take if run into any snags. Stay tuned!