Coverage Amounts

What determines your life insurance need?
Your life insurance needs change as your life changes. When you are young, you may not have a need for much life insurance. However, as you take on more responsibility and your family grows, your life insurance needs increase. You should periodically review your needs in order to ensure that your life insurance coverage adequately reflects your life situation.

Estimating your life insurance need
There are several simple methods you can use to estimate your life insurance need. These calculations are sometimes referred to as "rules of thumb" and can be used as a basis for your discussions with your insurance agent.

Income rule:
The most basic rule of thumb is the income rule, which states that your insurance need would be equal to 6 or 8 times your gross annual income. For example, a person earning a gross annual income of $60,000 should have between $360,000 (6 x $60,000) and $480,000 (8 x $60,000) in life insurance coverage.

Income plus expenses:
This rule considers your insurance need to be equal to 5 times your gross annual income plus the total of any mortgage, personal debt, final expenses, and special funding needs (i.e., college). For example, assume that you earn a gross annual income of $60,000 and have expenses that total $160,000. Your insurance need would be equal to $460,000 ($60,000 x 5 + $160,000).

Premiums as percentage of income:
Under this rule of thumb, a minimum of six percent of your gross income (as the primary income earner) should be spent on life insurance premiums. Add an additional one percent for each dependent. Once you determine the percentage of your income which should be spent on life insurance premiums, you should purchase as much life insurance as you can get for that premium amount.

There are several more comprehensive methods used to calculate life insurance need. Overall, these methods are more detailed than the rules of thumb and provide a more complete view of your insurance needs.

Family needs approach:
The family needs approach requires you to purchase enough life insurance to allow your family to meet its various expenses in the event of your death. Under the family-needs approach, you divide your family's needs into two main categories:

  • immediate needs at death (cash needs), and
  • ongoing need (net income needs).

Once you determine the total amount of your family's needs, you purchase enough life insurance to cover that amount.

Income replacement:
The income replacement calculation is based on the theory that the purpose of life insurance is to replace the loss of your income when you die. Under this approach, the amount of life insurance you should purchase is based on the value of the income that you can expect to earn during your lifetime, taking into account such factors as inflation and anticipated salary increases.

Estate preservation and liquidity needs:
The estate preservation and liquidity needs approach attempts to calculate the amount of life insurance needed upon your death for items such as taxes, expenses, fees, and debts, while preserving the value of your estate. This method takes into consideration the amount of life insurance needed to maintain the current value of your estate for your family, while providing the cash needed to cover death expenses and taxes.