There is no magic formula to determine the amount of life insurance you will need. However, you can make a reasonable estimate if you consider your present financial situation and deduce what your family and loved ones will need down the line.
A general rule for estimating the value of life insurance you will probably need is calculating the financial obligations (long term) you have and removing them from your assets. The amount is where the life insurance comes in.
Rules of thumb in Calculating Life Insurance
To quickly estimate your life insurance needs, one can use these proposed rules of thumb. It is better than working on a random guess that will not account for a substantial part of your financial life.
Rule 1: Multiply Your Income by 10
The only issue with this approach is that it does not account for your family's needs, savings, or any insurance policy you have. Also, there is no coverage amount to take care of stay-at-home parents that should have coverage even though they do not earn.
Should a stay-at-home parent die, the value they provide will have to be replaced. This will involve paying someone to continue with such services as childcare, which was free when the stay-at-home parent was alive.
Rule 2: Purchase a value ten times above your income with $100,000 for each kid for College Funds
If you have kids, one of the main expenses of your life insurance calculation is education. This rule adds a separate layer to the first rule. There is still the flaw of not accessing the family's needs deeply or any policy in place.
Rule 3: the DIME Approach
With this formula, users will have to take deep consideration of their finances compared to the first two. DIME means Debt, Income, Mortgage, and Education – four major areas one should note when estimating life insurance needs.
Debt with Final Expenses: Sum up your debt (without the mortgage) alongside proposed funeral expenses.
Income: Estimate how long the family will require support. With this number, multiply the annual income.
Mortgage: Deduce the value you need to take care of the mortgage
Education: project the funds you will need for the college expenses of your kids.
A summation of these whole obligations will give a better idea of what you need. Even though this is a pretty comprehensive formula, It still does not take care of the savings and insurance coverings that might have existed.
Essential Tips to Calculate Life Insurance
Here are essential tips for deducing your coverage needs
It would help if you did not plan the life insurance in isolation. Instead, the purchase should be part of a comprehensive financial plan. The plan should consider future expenses like college funds. With this information, you have a solid base to plan the insurance.
It is a good idea to purchase a little above what you estimate you will need. This is due to the high probability of income rising over the years, alongside the expenses. Even though one cannot correctly calculate the exact increase value, your loved ones will maintain a normal lifestyle.
Discuss the numbers with your spouse. You should know what your spouse thinks they will need to live when you are gone. Is your estimate feasible to them?
Buying a series of small insurance policies is a good idea, rather than a huge one. This will help vary your coverage as your needs flow and ebb.
If your kids are still small, you are better off going with an insurance plan that spans 30 years compared to a 20-year plan. A longer-term gives enough time to build up assets, and one will less likely be caught short, removing the need to be looking for coverage when the rates are high, and you are already old.
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