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4 Ways To Estimate How Much Life Insurance You Need
If you want to quickly determine your existing life insurance needs, an estimate can be an easy way to get a value. These methods are better than a random guess but often fail to account for important parts of your financial life.
1. Multiply your income by 10
The “10 times income” guideline is often shared online, but it doesn’t take a detailed look at your family’s needs, nor does it take into account your savings or existing life insurance policies. And it doesn’t provide a coverage amount for stay-at-home parents, who should have coverage even if they don’t make an income.
The value of a stay-at-home parent’s work needs to be replaced if he or she dies. At a bare minimum, the remaining parent would have to pay someone to provide the services, such as child care, that the stay-at-home parent provided for free.
2. Buy 10 times your income, plus $100,000 per child for college expenses
This formula adds another layer to the "10 times income" rule by including additional coverage for your child’s education. College and other education expenses are an important component of your life insurance calculation if you have kids. However, this method still doesn’t take a deep look at all of your family’s needs, assets or any life insurance coverage already in place.
3. Use the DIME formula
This formula encourages you to take a more detailed look at your finances than the other two. DIME stands for debt, income, mortgage and education, four areas that you should account for when calculating your life insurance needs.
Debt and final expenses: Add up your debts, other than your mortgage, plus an estimate of your funeral expenses.
Income: Decide for how many years your family would need support, and multiply your annual income by that number.
Mortgage: Calculate the amount you need to pay off your mortgage.
Education: Estimate the cost of sending your kids to school and college.
By adding all of these obligations together, you get a much more well-rounded view of your needs. However, while this formula is more comprehensive, it doesn’t account for the life insurance coverage and savings you already have. It also doesn’t consider the unpaid contributions a stay-at-home parent makes.
4. Replace your income, plus add a cushion
With this method, you’ll buy enough coverage that your beneficiaries can replace your income without spending the payout itself. Instead, they can save or invest the lump sum and use the resulting income to pay expenses.
To calculate the amount, divide your annual income by a conservative rate of return, such as 4% or 5%. As an example, let’s assume your income is $50,000 and you estimate a 5% rate of return. The math works like this: $50,000 divided by 5% equals $1 million. So if you buy a million-dollar life insurance policy and your beneficiaries put the payout into a bank account earning 5% annual interest, they can expect to generate $50,000 a year to replace your income.
When your dependents no longer need the income to meet daily living expenses, the $1 million can go toward other goals such as college tuition, home buying or retirement income.
To use this method for a stay-at-home parent, first add up how much it would cost each year to pay someone else to handle that parent’s tasks. Then plug that number into the formula as if it were the stay-at-home parent’s annual income.
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Term policies last a set period of time such as 20 years, while permanent policies last a lifetime. No-exam policies don't require a medical exam.
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