Mike S. from NJ asks, “How much term life insurance do I need?”
There’s an old-school rule that says when purchasing a term life insurance policy you should buy a policy equal to 10 times your annual income. This strategy may work in some cases, but the issue of providing for your loved ones is too important to leave to haste or old-school rules. Both leave you with an arbitrary number that doesn’t consider your real needs.
Carefully consider your debt obligations.
Many families rely on two incomes to cover their monthly expenses, the largest of which is usually the mortgage payment. If one or the other partner passes, the one remaining may not be able to afford to stay in the home. A home may have equity, which makes it feel like an asset to us, but on the monthly cash flow, it’s a real expense that has to be paid. If you still owe $150,000 on the mortgage, that should be the starting point. The final number will be higher.
How much do you owe for the cars and credit cards?
The average American family owes nearly $17,000 in credit card debt. Most have car payments as well. If a two-income household suddenly loses one income, even those monthly expenses that are much smaller than the mortgage can become crippling. Be sure to account for your car payments and other debt obligations when calculating how much life insurance you need.
Do you have children in school?
Young children will need food and clothing, of course, but their other activities cost money as well. Who will pay for band camp, braces, gymnastics or karate classes, and the big one: college or vocational school? With only one income, some of these things that make up a normal life may not be a reality unless you have enough life insurance.
Think carefully about the length of the life policy term.
Is a 10-year term policy long enough? How much longer will you be paying the mortgage? How long will it be until the kids are out of school and self-sufficient? You’ll want a policy that covers your family’s financial needs through those important events. Maybe a twenty-year term policy is a better fit for your needs, or maybe a 30-year policy. Many companies offer term life insurance policies with 10-, 20-, or 30-year options. If none of those is an exact fit, some also provide term options customized to your individual needs so that you aren’t paying for coverage you don’t need.
Adding years to the policy term will increase the premium amount, so it’s important to think about how long you will need the policy, thereby not paying for more insurance than you need, nor less. Life insurance becomes more expensive as you get older and closer to the finish line. Buying a term policy that outlives your coverage need will cost more money than you need to spend.
While the premium cost of a life insurance policy is a consideration, the cost shouldn’t be the primary reason for choosing a coverage amount or term. Most families can find a way to save a bit extra each month to cover the difference in cost between a policy that only provides for the basics and one that provides for your family adequately.
Your assets aren’t worthless, but they are worth less in a quick sale.
A home with equity isn’t a viable replacement for life insurance. Homes aren’t liquid assets. Finding a buyer at fair market value could take months. The same is true for cars, most household items and furnishings, and for many investments. Vehicles and belongings will not be worth as much if the pressure is on to sell quickly. Investments may be subject to withdrawal penalties and their sale may create tax liabilities.
Life insurance is the best option if you don’t have cash to meet your family’s needs.
So, how much term life insurance do I need to buy?
Add up your obligations and customize your coverage.
Add up your financial obligations during the term that the policy will be in force to be sure you are purchasing enough coverage to provide for your family should the unexpected happen.
If, for example, you have $200,000 in financial obligations over the next 10 years, and it looks like clear sailing after that time period, you have a good starting point. Shop for a 10 year term policy for up to $200,000. If some of your obligations will be paid down or gone altogether in the near future, a lower amount of coverage might be adequate. If choosing a lower coverage amount, be careful not to make dramatic cuts in coverage just for the cost savings. The goal is still to secure adequate coverage and plan for the unexpected.
In many cases, you’ll find that the cost of a well-chosen term life policy that adequately insures the needs of your family is less than your cell phone bill or your cable bill.
