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It’s not much fun to ponder our mortality, or our spouse’s. But once we have children or anyone who depends on us financially, our financial obligations grow. It’s time for some serious adulting.
That means planning for the unexpected. Life insurance helps ensure that if you or your spouse died unexpectedly, your family would be financially stable. For example, would your family have enough to cover the rent or mortgage without you? What about funeral expenses? (Here’s more on what life insurance is and what it can cover.)
After figuring out whether you need life insurance, the next question we usually hear is: “How much life insurance do I need?”
There are a few methods that experts commonly use for figuring this out.
The Income Replacement Approach
The “Analyze Your Needs” Approach
In a nutshell, life insurance is a contract between you and an insurer stating that if you were to pass away while your policy is active, the insurer would pay people you choose (your beneficiaries) a "death benefit." That's an amount of money you've agreed upon at the time you purchased your policy. We can call that the coverage amount.
Here's more on what life insurance is and how it works.
There are many different reasons to get life insurance, but the most common is to help out loved ones who rely on you for income. Do you have financial dependents like children? What about aging parents or siblings? Has anyone co-signed on your debts?
Here are more guidelines on whether you need life insurance.
The simplest way of answering "how much life insurance do I need?" is to calculate your coverage based on your annual income. While there’s not an easy one-size fits all answer, most experts agree that approximately 10 times your annual salary is a good goal.
“The amount of coverage you should get is different depending on if you are single or married,” says Zaneilia Harris, CFP and President of Harris & Harris Wealth Management Group. “I suggest single clients get insurance to cover at least one times their annual salary.” Those who are married with kids, she says, should consider purchasing enough insurance to cover 10 to 15 times their annual salary.
Dr. Brad Klontz, a financial psychologist, Certified Financial Planner and Associate Professor of Practice at Heider College of Business at Creighton University, suggests a slightly lower calculation. “The general rule of thumb is eight to 10 times your annual income,” he says.
Want a slightly more nuanced approach to determining how much coverage to get? Start by looking at various personal factors in your life. “Taking your entire financial picture into account is important,” says Klontz. “How are your kids going to pay for college? What about your mortgage?”
The "analyze your needs" approach is more precise than simply multiplying your income by 10. But if you're not game to add up every little expense and still crave an easy rule of thumb that's nonetheless a little more customized to your situation, consider thinking about "DIME."
That means totaling up your:
Debt and final expenses: This includes debt like car loans and co-signed credit cards but excludes your mortgage.
Income: This entails figuring out how many years your loved ones would need financial support and multiplying your annual take-home income by that amount.
Mortgage: At the time you're applying for life insurance, how much is left on your mortgage?
Education: How much do you predict it'd cost to send your kids to college, and what percentage of that tuition would you like to cover through life insurance?
This take on the "analyze your needs" approach is a little more involved but more precise. To get started, follow these three steps:
Total your fixed costs
Figure out your "income replacement" needs
Subtract your assets
(Not sure how to set up life insurance coverage when you have multiple kids with a large age gap? We'll help show you your options.)
Consider the following numbers as you determine your life insurance needs:
Your current debts (including a mortgage and other committed expenses)
Long-term goals, like paying for retirement or for your child’s education
Final expenses such as funeral costs
Start by totaling these potential costs that you’d want to cover if you weren’t around.
Some of these expenses can really sneak up on you, so it’s good to be thorough. For example, the median cost of a funeral with a viewing and burial runs more than $7,000—and that doesn’t include flowers, the expense of printing an obituary or food for the post-service reception.
Next, think about:
How much income your family needs each year to get by, adjusted for any additional expenses such as extra childcare, health insurance or housekeeping if you weren’t around
How much income your spouse or partner makes
Do the subtraction: How big is the gap between those two numbers? This should lead you to a clearer number for how much money your family might need as “income replacement” on an ongoing basis. (Up to you, but you might choose to build in a little buffer just in case your partner were to experience a period of unemployment, or had to take a job with less pay down the line.)
One more thing to consider: If one spouse is a stay-at-home parent or works part-time and doesn’t have access to health insurance through their job, you may want to add more life insurance on the working spouse. This provides a more generous buffer and prevents the stay-at-home or part-time working parent from scrambling for a job with health insurance if the breadwinner were to pass away.
After that, decide how many years you want this “income replacement” money to last. Do you want to provide this for 20 years? Or do you think that your spouse could make do with a five-year runway?
Whatever you decide, multiply your “income replacement” amount by the number of years you want your family to have that extra support.
Add that to your total fixed costs.
Total up what you do have already in the bank:
Your current assets and retirement funds
Now subtract those assets from the total you’ve been working on. This is a general estimate of how much life insurance, the coverage amount, you might want to apply for.
Let's say you have $100,000 left on your mortgage, plus $20,000 in co-signed student loans. We'll assume that your family would hold you a fairly frugal funeral, so we'll guesstimate $6,000 for final expenses, which is a bit below the average.
In this example, you have two kids and want to fully cover their tuition at a state school, but don't feel the need to pay full freight if they choose to go private. As of December 2020, average in-state tuition in Pennsylvania (which we just chose as an example) is about $24,000 a year. You assume that tuitions will go up in the decade and a half before your kids start college, so you choose to allocate $35,000 a year just in case.
In this example, you and your spouse have some retirement savings, but not a lot. You've been assuming that you'll both keep working several decades longer and save more money during that time. If you were to pass away unexpectedly, your spouse would struggle to retire comfortably based on savings from their salary alone.
So let's say you'd like to leave them an additional $100,000 to add to their retirement accounts so that amount could grow over time and help offset the lack of your share of retirement savings.
Let’s say you make $50,000 a year, and so does your spouse, for a grand total of $100,000. Let’s also say that you are pretty frugal and can get by as a family on $70,000 per year.
If you were no longer around, your family would only make $50,000 total (that’s how much your spouse earns in this example), which means that they’d come up short by $20,000. So maybe you say that your income replacement number is $20,000. Or, if you wanted to build in a little buffer or breathing room, maybe you call it $25,000 a year.
Let's say you want to provide that income replacement for ten years.
Student debt: $20,000
Final expenses: $6,000
College education: $35,000 a year x 4 years x 2 kids = $280,000
Income replacement: $25,000 a year x 10 years = $250,000
That total comes out to $756,000.
Now let's say that you and your spouse have some assets saved up, with about $5,000 in the bank. Subtract those assets, and in a case like this, it may make sense for you to choose a coverage amount around $750,000.
Remember, this is only an illustrative example and does not reflect a real person's true-life situation. For your own individual needs, please examine your needs specifically and consult with an expert if you have questions.
There are two main types of life insurance to consider—term and whole life insurance.
Whole life insurance provides a benefit to your beneficiaries no matter when you pass away, so long as you stay on top of your premium payments.
Term life insurance, on the other hand, provides coverage only for a particular time frame, like 10, 20 or 30 years. (As a result, term life premiums tend to cost a lot less than whole life premiums.)
Which type of insurance is right for you will depend on your personal situation. That said, for many parents with young kids, term life insurance makes the most sense because it's so affordable and covers them during the period of their greatest financial need. (In other words, while they're raising children.)
If you’re looking at term life insurance and trying to figure out how long you should be covered, this life insurance calculation is refreshingly simple: Most experts recommend purchasing coverage that extends until your youngest will have completed college.
If the dependents you’re seeking to provide for aren’t children (think: aging parents or a non-working spouse), you may need a different approach to determine what would be enough life insurance coverage.
In the case of an aging parent, you might select a term that you’d expect to last for the remainder of their life.
For a non-working spouse, you might choose a term that would last until they are old enough to access Social Security and/or retirement benefits.
Depending on your situation, there are some cases when 10-year term life insurance might make the most sense, others when 15-year term life insurance suits your needs and yet more cases when 20-year term life insurance works for your family.
Just because a stay-at-home parent isn’t bringing in an official salary doesn’t mean they should skimp on life insurance coverage.
“A stay-at-home parent is a major contributor to the household,” says Harris. “That parent is worth at least $60,000 to $100,000 to the household.”
That number may sound like a lot when you’re up to your elbows in dirty diapers, but consider that if a stay-at-home parent were to die, the remaining spouse would need to pay for childcare, housekeeping and pet care, not to mention all the other facets of life the stay-at-home parent may be in charge of, like meal planning and preparation and errand running.
To figure out how much life insurance to get for a stay-at-home parent, tally up what it would cost to farm out all the services the stay-at-home parent provides; according to Salary.com, the financial value of a stay-at-home mom in 2019 is worth nearly $180,000 per year.
From there, you can use the income replacement approach and multiply that amount by 10 to determine the approximate coverage amount.
The cost of life insurance depends on a number of factors. The underwriting process looks at things like your health situation and financial details to determine your levels of risk. That, in turn, will inform whether an insurer can offer you a policy at all, and for how much.
Term life insurance tends to be much more inexpensive than whole life.
While it's great that many employers offer group life insurance as an employee benefit, this is often not sufficient. First, many of these policies have relatively low coverage limits, such as $50,000. As we've seen from the examples and calculations above, that's simply not enough for a lot of people.
Additionally, you may not be able to take the policy with you when you leave your job. Or, if you can convert your group policy into an individual policy, there's a good chance you'll have to pay significantly more for coverage if you do so.
This will depend on your individual situation, but in most cases it will make sense for both of you to be covered. That way, if either of you passes, the other one will have financial means to get by.
Same goes if one of you is a stay-at-home parent. Just remember the cost of additional childcare and household work if they were no longer here. Plus, you might want to leave each other a financial buffer in case the surviving spouse needs some bereavement time away from work.
Factor in, as well, that each of you might have distinct financial burdens. For example, one of you may have co-signed student loan debt even if the other doesn't. Additionally, one of you might plan to financially support aging parents now or in the future.
While some spouses carry the same amount of coverage, note that you don't have to insure yourselves for the same amount.
Generally speaking, you shouldn't take out a policy on someone unless their passing would mean a financial loss for you. The death of a child, for example, would be traumatic but may not actually be a financial hurdle since children cost money to raise but typically don't contribute financially.
Here's more on what it means to take a life insurance policy out on someone else.
Not everyone needs life insurance. Broadly speaking, if you have no one who depends on you financially, no mortgage, no debts and your family can afford your final expenses, you may not need life insurance.
Of course, we've met many people who think they don't need life insurance... but really do.
If you aren't easily able to identify your retirement needs or how much you can or should be saving for your kids' college education, it may make sense to consult a financial planner. They may be able to help you understand the broader picture of your inflows and outflows, and how much life insurance would suit your needs.
There's a good chance that your income will increase over the years, so you might eventually outgrow a rule of thumb such as the "ten times your income" guideline. You can only take your best guesses based on what you know now, but just remember to think about where you might be in the future, rather than underestimating.
Of course, it will often make sense to go through these thought experiments with your spouse or partner, since they'll be very much affected by the decisions you make. Here's what you should know about shopping for life insurance together.
Engage your spouse in a conversation about what's important to both of you, and how you'd like to help care for your family if the worst were to happen. Does your spouse have any concerns or expenses in mind that you might not have considered?
For example, if you have a child with special needs who will required financial support beyond reaching adulthood, you might want to consider whole life insurance so your coverage doesn't expire. For unique situations such as these, we encourage you to speak to an estate planning expert for questions relating to your individual situation.
Besides increasing your peace of mind, purchasing coverage now can have another big benefit: Life insurance premiums rise as we get older.
“Getting insurance while you’re young, before you have major health issues, is key to keeping your costs low,” says Harris.
Purchasing term life insurance is one of the most potent ways to protect your family against the unforeseen. “You don’t have control over when you die or how you die, but you can have a lot of control over how your family is going to experience the impact,” says Klontz.
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Fabric by Gerber Life exists to help young families master their money. Our articles abide by strict editorial standards.
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