How to Calculate Your Life Insurance Needs in 3 Easy Steps

Life insurance is one of the most important financial products you can buy to protect yourself and your loved ones from financial hardship in case of your death. It can provide peace of mind, security, and income replacement for your family or beneficiaries.

However, life insurance is not a one-size-fits-all solution that you can buy and forget. It requires careful planning and decision-making to ensure that you get the right amount of coverage for your needs and budget.

According to a 2021 study by LIMRA and Life Happens, only 54% of Americans have some form of life insurance coverage, and among those who do, 25% say they need more. Moreover, 41% of Americans say they would face financial hardship within six months if their primary wage earner died.

If you are one of those who are unsure about how much life insurance you need or want to learn more about it, this article is for you. We will explain how to calculate your life insurance needs in 3 easy steps: estimate your financial obligations, subtract your existing assets, and compare quotes from different insurers.

Step 1: Estimate Your Financial Obligations

Your financial obligations are the main factor to consider when calculating your life insurance needs. They are the amount of money that your family or beneficiaries would need to maintain their standard of living and achieve their objectives if you were no longer around.

Some examples of common financial obligations are:

• Income replacement: This is the amount of money that your family or beneficiaries would need to replace your lost income for a certain period of time, such as until they become independent or retire. This income replacement should cover their current and future expenses, such as housing, food, utilities, transportation, health care, entertainment, etc.
• Debt repayment: This is the amount of money that your family or beneficiaries would need to pay off any debts that you leave behind, such as mortgage, credit card debt, car loan, student loan, etc. This debt repayment should prevent them from falling into financial trouble or losing their assets.
• Funeral costs: This is the amount of money that your family or beneficiaries would need to cover your final expenses, such as funeral service, burial or cremation, casket or urn, etc. This funeral cost should spare them from any additional stress or burden.
• Education costs: This is the amount of money that your family or beneficiaries would need to fund the education of your children or grandchildren, such as tuition fees, books, supplies, room and board, etc. This education cost should ensure that they can pursue their academic goals and dreams.

There are different ways to estimate your financial obligations, but here are some common methods or rules of thumb that you can use:

• Multiply your income by 10 or 10 plus college costs per child: This method estimates how much income you would earn over your remaining working years and multiplies it by a factor that accounts for inflation and interest. For example, if you are 40 years old and earn $50,000 per year, and you plan to work until 65, you could multiply your annual income by 10 to get $500,000 as your coverage amount. If you have two children who will attend college, you could add another $100,000 per child to get $700,000 as your coverage amount. This is a simple and popular method, but it does not consider your specific expenses or goals.
• Add up your debts and future expenses: This method calculates how much money you owe or anticipate owing for various financial obligations, such as mortgage, credit card debt, car loan, student loan, funeral costs, education costs, etc. For example, if you have $100,000 in debt, $200,000 in mortgage balance, and $100,000 in education costs for your children, you could add these amounts ($400,000) to get your coverage amount. This is a more detailed and customized method, but it may not account for future changes or contingencies.
• Use a life insurance calculator: This method uses an online tool that takes your personal and financial information into account and gives you an immediate result. For example, you can use this life insurance calculator by Forbes Advisor to estimate your life insurance needs. You just need to enter some basic data, such as your annual income, years of replacement income you may need, debts, savings, and other life insurance coverage—and you will get a result instantly. This is a more convenient and accurate method, but it may not capture all the nuances or variables of your situation.

Step 2: Subtract Your Existing Assets

Your existing assets are the amount of money that your family or beneficiaries can use to pay for your financial obligations if you were no longer around. They are the resources that can reduce your life insurance needs.

Some examples of common existing assets are:

• Savings: This is the amount of money that you have in your bank accounts, such as checking, savings, or money market accounts. This savings can be easily accessed and used for any purpose.
• Investments: This is the amount of money that you have in your investment accounts, such as stocks, bonds, mutual funds, or exchange-traded funds. This investments can be liquidated and used for any purpose, but they may incur taxes or fees.
• Retirement accounts: This is the amount of money that you have in your retirement accounts, such as 401(k), IRA, or pension. This retirement accounts can be withdrawn and used for any purpose, but they may incur taxes or penalties.
• Existing life insurance policies: This is the amount of money that your family or beneficiaries would receive from any life insurance policies that you already have, such as term, whole, universal, or variable life insurance. This existing life insurance policies can be used for any purpose.

To subtract your existing assets from your financial obligations, you need to consider some tips or cautions, such as:

• Do not rely on employer-provided life insurance: Many employers offer group life insurance as a benefit to their employees, usually equal to one or two times their annual salary. However, this life insurance is not portable, meaning that you will lose it if you leave or lose your job. Therefore, you should not count on it as a reliable source of income for your family or beneficiaries.
• Do not count assets that are illiquid or earmarked for other purposes: Some assets may not be readily available or suitable to use for paying your financial obligations. For example, your home equity may be illiquid, meaning that you cannot access it unless you sell your home. Your 529 plan may be earmarked for your child’s education, meaning that you cannot use it for other expenses without incurring taxes or penalties. Therefore, you should not include these assets in your calculation.
• Do not overestimate the value of your assets: Some assets may lose value over time due to inflation, market fluctuations, or depreciation. For example, your car may be worth less than what you paid for it due to wear and tear. Your stock portfolio may be worth less than what you invested in it due to market downturns. Therefore, you should use conservative estimates of your asset values and update them regularly.

Step 3: Compare Quotes from Different Insurers

Once you have calculated your life insurance needs by subtracting your existing assets from your financial obligations, you need to compare quotes from different insurers to find the best deal for your coverage.

The cost of life insurance depends on several factors that affect the risk of insuring you. The higher the risk, the higher the premium. Some of these factors are:

• Your age: The older you are, the more likely you are to die, and the more expensive your life insurance will be.
• Your health: The healthier you are, the less likely you are to die, and the cheaper your life insurance will be.
• Your lifestyle: The safer and cleaner your habits are, the less likely you are to die, and the cheaper your life insurance will be.
• Your occupation: The less dangerous or stressful your job is, the less likely you are to die, and the cheaper your life insurance will be.
• Your family history: The fewer genetic or hereditary diseases or conditions in your family, the less likely you are to die, and the cheaper your life insurance will be.
• Your type and amount of coverage: The longer and larger your coverage is, the more likely you are to die within the policy term, and the more expensive your life insurance will be.

The cost of life insurance also varies by insurer, as each one has its own underwriting criteria, pricing models, and discounts. Therefore, it is important to compare quotes from different insurers before buying a policy.

To compare quotes from different insurers, you can use online tools or brokers that can help you find the best deal for your coverage. You just need to enter some basic information about yourself and your desired coverage, and you will get multiple quotes from different insurers in minutes. You can then compare the prices, features, ratings, and reviews of each insurer and choose the one that suits your needs and budget.

Some tips or strategies to find affordable and suitable life insurance are:

• Shop around: Compare quotes from different insurers and use online tools or brokers to help you find the best deal. You may be surprised by how much prices can vary for the same type of coverage.
• Buy early: The younger and healthier you are, the cheaper your life insurance will be. Buying early can also lock in your rate and avoid future increases due to age or health issues.
• Choose term over permanent (if appropriate): Term life insurance is usually much cheaper than permanent life insurance for the same amount of coverage. If you only need temporary protection for a specific period of time, term life insurance may be a better option for you.

• Improve your health and habits: The healthier and safer you are, the cheaper your life insurance will be. You can lower your premiums by quitting smoking, losing weight, exercising regularly, eating well, managing your stress, and avoiding risky activities.
• Bundle with other policies (if available): Some insurers may offer discounts or incentives if you buy more than one policy from them, such as life, home, auto, or health insurance. This can save you money and simplify your payments and claims.
• Review your coverage periodically: Your life insurance needs and costs may change over time due to life events, such as marriage, divorce, birth, death, retirement, etc. You should review your coverage periodically and adjust it accordingly to avoid paying for too much or too little.

Conclusion

Calculating your life insurance needs is not a difficult or complicated task if you follow these 3 easy steps: estimate your financial obligations, subtract your existing assets, and compare quotes from different insurers.

By doing so, you can ensure that you have adequate and affordable life insurance coverage that can protect you and your loved ones from financial hardship in case of your death.

If you are ready to buy a life insurance policy or review your existing one, we recommend that you use our life insurance calculator or consult a professional to help you find the best deal for your coverage.

Remember, life is unpredictable and precious. Don’t wait until it’s too late to protect yourself and your loved ones with life insurance.