Most Americans are aware of the financial safety net life insurance provides, but many U.S. households say they don't have enough life insurance, according to research group LIMRA's life insurance report.
LIMRA's life insurance needs analysis suggests that most families need 5.25 years of income replacement in a policy, but the average household has just three. Nine million households that own only group life insurance have an average life insurance gap of $225,000.
What's worse is 43% don't have any coverage at all, LIMRA found in its 2019 Insurance Barometer Report.
Certainly some coverage is better than nothing, but how much is enough?
There is no simple formula that can answer that question. Most people purchase life insurance to replace income they would have provided their families. However, simply multiplying your income by a certain number doesn't provide a complete estimate for how much your family will need. And if you're a parent, you likely need life insurance even if you don't work outside the home and earn an income. You should have enough coverage in that case to cover the cost of services you provide the family for free, such as child care.
The time you spend thinking through your family's needs now will pay off later if the unexpected happens. Follow these five steps to estimate how much life insurance to buy:
1. Calculate your final expenses.
The national median cost of a funeral with viewing and burial is more than $8,000. That's not including the cost for the cemetery, marker, crematory fees or flowers, according to the National Funeral Directors Association. Those expenditures, along with fees for death certificates and obituaries, can bring the price up to around $10,000.
Other final expenses include your uncovered medical bills and estate-settlement fees. Typically your final expenses will be about $15,000 or 4% of your estate.
2. Add up your debts.
How much do you owe?
Removing the debt load will enable your family to breathe easier when you're no longer around to help shoulder the burden.
Total up all your outstanding debt, including:
- Credit card balances
- Car loans
- Private student loans
- Home equity loans
3. Estimate ongoing expenses.
How much annual income would your loved ones need to maintain their lifestyle if you died tomorrow?
Consider the cost of all the things they'll need -- clothing, food, utilities, school fees, children's activities, transportation, home maintenance, child care, health care, insurance and other expenses.
Now subtract income they would get from other sources, such as your spouse. Then multiply the result by a factor based on the number of years they would need the income, advises the life insurance education non-profit association LifeHappens.org:
- For 10 years, multiply the figure by 8.8
- 15 years, multiply by 12.4
- 20 years, multiply by 15.4
- 25 years, multiply by 18.1
- 30 years, multiply by 20.4
Multiplying by the factor helps you estimate the amount of capital you need today to meet future needs, the foundation says. The factors are based on an annual 6% investment return and annual 3% inflation rate for living expenses.
4. Account for long-term financial needs.
Estimate the cost of any long-term expenses, such as the cost of college for your children.
The average price of education varies widely by school. The average annual cost of tuition and fees for the 2017-18 school year was $36,880 at private colleges, $10,440 for in-state students at public colleges and $25,620 for out-of-state students at state universities, according to The College Board.
Keep in mind that those are "sticker prices." Many students pay less because of financial aid. Still, the cost of an education has escalated, and chances are the price of putting your kids through school will continue to go up. The College Board's website features more information about college costs and what to expect.
LifeHappens.org recommends multiplying the total estimated college cost by a factor associated with the number of years before your children attend college. The factors are based on an annual 6% return on investment and 5% annual inflation rate for college costs. The factors are:
- .95 for five years before college
- .91 for 10 years before college
- .86 for 15 years before college
- .82 for 20 years before college
5. Subtract financial resources
Now consider the financial resources from which your family could draw. This would include any other life insurance coverage you have, such as group life insurance through your employment. It would also include any savings and investments you have, other than those for retirement.
Now add up the totals from steps one through four. From this sum, subtract the financial resources your family will have.
Your final total is an estimate for how much life insurance you need. Learn about the different types of life insurance policies available and use this figure when you get life insurance quotes.