How Much Life Insurance Do You Need?
Updated February 2, 2023
Reading time: 7 minutes
Though nobody likes to think about their death, preparing financially in case something unexpected happens to you is important. The essential aspects of estate planning include drafting a will, establishing power of attorney and advanced directives, and ensuring the financial security of your family in the event of your death.
A life insurance policy may help provide financial security for your family if you pass away. Term life coverage is sufficient for most people, though your unique situation will influence your coverage needs.
Here’s what you should know about purchasing life insurance, why it’s important, and how to determine how much you need.
It’s important to consider your personal situation when determining how much life insurance coverage you need. Factors to consider include whether you have dependents, your finances, and your salary.
If you have a spouse or children, you may be more likely to want life insurance coverage to provide income replacement if you die. That way, your family can maintain their standard of living or cover future costs. Think about how much your family spends now versus potential future costs when considering how much life insurance you need.
For instance, you might look at your current monthly expenses, including costs for housing, child care, utilities, credit cards, groceries, leisure, and other expenses. You might also consider any future expenses, like college tuition for your child, as you calculate how much life insurance coverage you need.
Would your partner be able to afford these costs without your income, or would they struggle financially? If you’re concerned, purchasing a policy large enough to replace several years’ worth of income could make sense.
Read More: How Much Does Life Insurance Cost?
You must consider both your current and future resources when making life insurance decisions. This extends beyond your annual income to future Social Security benefits, your pension, retirement savings, and income from rental properties and other assets.
Future expenses are also an important consideration. Potential costs to consider for your partner include living expenses in retirement, healthcare costs, end-of-life expenses, and more. Factoring in college expenses also makes sense if you have young children. If you’ve saved a large sum of money, you might opt for less life insurance coverage.
You may hear that you should purchase a life insurance policy equal to 10 times your annual salary, but you could want even more coverage depending on your situation.
Let’s say your annual salary is $75,000. If you purchase $750,000 worth of life insurance coverage, your family will have the equivalent of 10 years’ worth of your income if you pass away. You must ask yourself whether this will cover all future needs.
If you plan to pay for college tuition — especially for more than one child — it might not be. Estimating the cost of college for each child and adding that figure to the $750,000 could make more sense for your situation. If you’ll be paying roughly $100,000 for two children, it might be worth purchasing $950,000 of life insurance coverage.
When it comes to life insurance, you have many options to choose from. Many people find term life coverage sufficient, but other coverage options are also available.
With a term life policy, you purchase life insurance coverage for a set time period. For instance, you might opt for a 30-year term life policy totaling $1 million. Insurers commonly offer coverage for terms of 10 to 30 years, and coverage amounts vary depending on the company you choose.
Term life coverage typically comes with affordable premiums, often totaling just a few hundred dollars a year. This makes this type of coverage a smart choice for budget-focused people and families. Just be aware that your term will eventually expire, so another type of life insurance could be a better option if that expiration is a concern. You may also need to meet certain requirements, such as being younger than 60, to qualify for term life coverage.
As the name suggests, whole life insurance is permanent coverage that pays out a guaranteed death benefit. Provided you stay current on your premiums, you won’t need to worry about your policy expiring after a set term. Premiums don’t change over time with whole life coverage.
In addition to paying out a death benefit, whole life insurance provides a savings component that builds cash value as you pay your premiums. Once you build up a cash reserve, you can opt to borrow against it, use it to supplement your retirement savings, and more.
Whole life coverage typically costs more than term life coverage, with premiums adding up to several thousand dollars each year depending on the size of your policy.
Like whole life coverage, universal life insurance is permanent as long as you pay your monthly premiums. It also provides a cash value component and a guaranteed death benefit.
Despite the similarities, universal life insurance works slightly differently than whole life insurance. With universal life coverage, you can often adjust your premiums and death benefit over time, though the specific rules can vary by insurer.
For instance, if you’ve been paying into the policy for several years, you might opt to decrease your premiums if a large cost arises. Or as you get older, you might want to increase your death benefit.
Premiums for universal life coverage typically cost less than premiums for whole life coverage but exceed what you’d pay for term life insurance.
Learn More: Types of Life Insurance
When you apply for life insurance, your insurer will ask for your name, age, gender, health information, and family history. This information, as well as the type of policy you want, helps determine the cost of your life insurance.
Age: In general, the younger you are when you get coverage, the more affordable that coverage may be. Life insurance companies tend to view younger people as less susceptible to serious health risks.
Gender: Men typically pay more for life insurance coverage than women due to shorter life expectancies.
Health status: You may also pay less for coverage if you don’t have any health issues. Fewer health issues generally means lower risk for insurance companies to take on.
Family medical history: Your family medical history will also factor into the cost of your coverage. If you don’t have a family history of serious health issues, your premiums could be lower.
Occupation: Whether your occupation is low-risk or high-risk can also play a role. If you work in a high-risk profession, you might end up with more expensive life insurance coverage. The American Psychological Association includes jobs in agriculture, construction, emergency response, and healthcare as high-risk occupations.
Lifestyle: The insurance company will want to know if you smoke, use drugs, or have any past driving violations. The lower the risk your lifestyle presents, the more affordable your coverage is likely to be.
Chosen policy type: Your policy type will also affect the cost of your premiums. Term life policies generally cost less, while whole life policies often cost the most for policyholders.
Policy size/coverage amount: If you opt for a larger amount of coverage, you’ll also likely pay higher premiums than you would with a smaller amount of coverage.
Life insurance rider: A life insurance rider, or add-on, can be used to customize or change your policy. For instance, you might add an accelerated death benefit rider to help cover your medical costs if you contract a terminal illness. Depending on your insurer and the add-on you need, riders may or may not affect your premium costs.
See More: Best Life Insurance for Seniors
While your individual history and coverage needs will affect your costs, life insurance could be more affordable than you think. The cost of term life coverage is often overestimated by a large margin, according to a 2022 Life Insurance Marketing and Research Association and Life Happens study.
The study indicates that the average cost of a 20-year $250,000 term life policy for a healthy 30-year-old is around $170 per year. But more than half of survey respondents thought the policy would cost over $500 annually. This overestimation of costs presents a barrier that may stop people from purchasing coverage.
Term life is typically the least expensive coverage. If the same 30-year-old opted for a $250,000 whole life policy, they’d likely pay over $2,000 in annual premiums, while premiums for universal life insurance may be over $1,000 per year.
Here are some answers to commonly asked questions about determining how much life insurance coverage you need.
Several factors help determine your life insurance rates, including:
Family health history
The type of policy you choose and the amount of coverage you’re seeking will also affect your premium costs. For instance, term life insurance rates tend to be lower than whole life insurance rates.
While term life insurance coverage works well for many people, the right type of life insurance for you will vary depending on your needs and situation. Some people may prefer whole life or universal life coverage for the guaranteed death benefits — despite the higher premiums. Others may find that term life is more affordable and suits their needs just fine.
Your premiums will likely be lower if you purchase life insurance coverage when you’re young. Of course, the insurance company will consider other factors besides your age when determining your premiums. But if you’re young, in good health, and don’t have any serious health issues in your family, it could be a good time to get coverage.
While insurance companies look at several factors to help calculate your premiums, certain personal information won’t affect the cost of your coverage. Those factors may include:
Jess is a personal finance writer who's been creating financial and business content for over a decade. Her work is published on Investopedia, MoneyWise, NextAdvisor, The HuffPost, and more. Prior to freelancing full-time, Jess was an editor at Investopedia, The Balance, and FinanceBuzz. Connect with her on LinkedIn.Learn More