To determine how much insurance to carry, use your annual income. You can estimate how much life insurance your family might need by using the "10 times earnings" rule of thumb. Using this strategy, you would buy a life insurance policy with a death benefit equal to 10 times your yearly salary. A general rule of thumb is never the best way to figure out how much life insurance you need because some people suggest higher or lower amounts, but it can still be useful for getting a rough idea of how much coverage you need or as a starting point. We'll look at the benefits and drawbacks of this rule, how to apply it, and potential alternatives to this streamlined method in this article.
Main points
- You can estimate how much life insurance you need by multiplying your annual income by 10 as a "quick and dirty" method (or add a zero to your annual income).
- Other approaches analyze your costs and project future changes in your finances to determine your coverage requirements.
- Before making crucial decisions like how much life insurance to purchase, it is best to conduct a thorough review of your needs because rules of thumb can oversimplify complex topics.
What Constitutes the Optimal Amount of Life Insurance?
According to a common guideline for life insurance, you should have one or more policies with a total death benefit equal to about 10 times your yearly salary (before taxes and other paycheck deductions). Your beneficiaries can use the death benefit they receive when the insurance policy pays out to support themselves after you pass away. This is a condensed method, like all rules of thumb. It doesn't carefully consider your finances (aside from your income), your current assets, or the needs of your beneficiaries. Even though this method can let you know if you're significantly underinsured, purchasing life insurance this way is probably not the best option. In an ideal scenario, you'd conduct a more thorough analysis of your requirements in order to determine the right number. The 10-times-earnings rule, however, can be a good place to start if you're looking for a quick estimate. If you have children, you could modify this rule by including an additional $100,000 or more to cover the cost of each child's education.What Is the Source of the Rule of Thumb for Life Insurance Coverage?
The income-based rule of thumb is a well-liked method of determining how much life insurance you need because the calculation is quicker and simpler than more complicated ones, like those that take into account all of your assets, debts, and future earnings. According to Paul Moyer, a life insurance agent and financial educator in South Carolina, when life insurance agents complete analysis for clients, they arrive at a proposed death benefit designed to cover basic needs, and that sum typically comes in at around 10 times your salary. Although the exact origin of this particular rule of thumb is unclear, it has long been used to calculate how much insurance you need based on your income.A Comparison of the DIME Formula, the Income Rule, and Other Options
When purchasing life insurance, other generalizations that adopt a different strategy than the income rule might be preferable. Debt, Income, Mortgage, and Educational Attainment The DIME formula, which emphasizes four factors, is one common life insurance rule. Debts: Total up all outstanding loans, excluding mortgages. Divide your yearly income by the estimated number of years your dependents will require support. For instance, it might not be until your youngest child completes college. You might skip this step if no one is dependent on your income. Calculate your total home debt, including any second mortgages or lines of credit. Estimate how much it will cost to send any children you have to school. When you add up the aforementioned costs, you can get an idea of how much insurance you might need to purchase. If you already have one or more insurance policies, you could lower that amount; otherwise, you could raise it to account for anticipated raises over the course of your career. Instead of emphasizing your current income, the DIME formula concentrates on particular spending categories. It might therefore be more likely to meet your family's basic needs. However, if your beneficiaries incur expenses that don't belong in any of those four categories, they risk running out of money. The DIME method can be modified to account for extra costs like retirement funding or medical expenses.Alternative Methods
You can also use a number of additional, sometimes complicated methods to figure out how much life insurance you require. The Human Life Value approach, for instance, makes use of more intricate calculations to determine the present economic value of your expected future earnings over a specified period of time. Additionally, you could decide on the number of years and the annual sum you'd like to give your survivors in the form of an income or income supplement. Then, based on a conservative rate of interest, you can use a financial calculator to determine a death benefit that could provide that sum. The 10-times-income rule is most likely the simplest to calculate, but this ease of use could reduce its accuracy.Salty Grains
You can get a general idea of the appropriate coverage amount by using rules of thumb. But it's crucial to conduct a careful analysis of your family's needs when choosing something as significant as life insurance. Here are some ways the income rule of thumb can be inadequate: People without jobs are ignored, perhaps because they are taking care of children. You might assume that if you have no income, you need very little to no insurance. However, it can be expensive to substitute for a parent who stays at home. According to a 2018 study, a stay-at-home parent is worth roughly $162,581. You might purchase a policy that is too small if your income is currently low but expected to increase. The 10x rule may not provide you with enough insurance to cover your debts if you have high debt levels in comparison to your income. Family members with special needs might need extra money to get the care they need. Your existing assets are disregarded by the rule. You might not require additional life insurance if you are self-sufficient financially.How Can I Determine the Amount of Life Insurance I Need?
If you decide to go by a rule of thumb based on your income, multiply your gross income (before taxes and other payroll deductions) by your multiplier. For example, if your annual salary is $70,000 and you want to receive ten times that amount, multiply $70,000 by ten to get $700,000 (or simply add a 0 to your annual income). You can use this formula for each wage earner in your household. For instance, using this rule of thumb, two parents making $70,000 each would each buy $700,000 worth of insurance. Although it is impossible to predict the future, it is essential to try to determine the ideal death benefit. Your loved ones may suffer financially after your passing if you have inadequate insurance. However, if you have more insurance than is necessary, you'll pay more in premiums (which is rarely, if ever, the case when a policy pays out).