How much life insurance do I need?

Buying life insurance means estimating what those left behind will need if you die. There are quite a few things to consider when calculating how much life insurance you should buy.

Consider what financial resources you have

Think about what kind of financial support will be available to survivors after your death, including existing life insurance policies.

"For simplicity, ponder three categories of resources: Social Security and other retirement-related survivor benefits; group life insurance; and other assets and resources," says Mark Friedlander director of Corporate Communications for Insurance Information Institute. "It's also important to know when these resources will become available. For example, Social Security survivor benefits are payable immediately to a surviving spouse with dependent children but only after age 60 if there are no children."

Think about current and future financial needs

Forecast what financial needs your survivors will have after your death. Think about three categories of requirements:

  • Final expenses (funeral and burial costs, probate and other estate administration costs, and medical expenses not covered by health insurance)
  • Debts, including credit cards, mortgages, car loans, student loans, and personal loans
  • Income and living expenses
  • College tuition for your children

Once you know what kind of financial protection your family will need, you can move to the next step.

Subtract the financial resources from financial needs

Now that you’ve thought about your survivors’ financial resources and needs if you were to die, you can now determine the size of the life insurance policy that you need.

"Many people are underinsured, often because they skip these steps or take a shortcut, such as simply buying a multiple of their annual income," Friedlander says.

    Types of life insurance

    You also need to figure out what type of life insurance you want. Life insurance is divided by two types: term life and permanent life insurance.

    Term life is for a period, such as 20 or 30 years. These policies are usually more affordable than a permanent life policy, but you can also outlive a term policy.

    A permanent life insurance policy is for life -- as long as you stay current on your premiums. Permanent life policies include whole life, universal life, and variable life. These policies build cash value, which allows you to tap into the policies while you’re still alive. They also often include riders, so you can customize the policy.

    Life insurance calculator

    Want to know how to determine how much life insurance you need? Use our helpful life insurance calculator.

    The free tool offers life insurance needs analysis. All you need to do is include your debts, income, and a few other factors and the tool will estimate what kind of life insurance policy you need and the policy’s length and amount of life insurance you may need.

    What is the minimum life insurance policy you need?

    If you're going to purchase a life insurance policy, you want to be sure that it will provide a death benefit minimum to any named beneficiaries. That can ease their financial burdens after your passing.

    "You need at least enough life insurance to cover the cost of your burial, pay off debts that will survive your passing, and to leave a little nest egg for your loved ones," advises Cade.

    Some people purchase only enough insurance to cover their funeral and burial costs, usually in the form of an affordable special permanent life policy known as final expense insurance.

    Whether that funeral insurance is enough depends on your assets and debts -- and potential future costs like a child’s college education.

    Who needs life insurance?

    Good candidates for life insurance include anyone who has significant financial obligations that would be a burden to those left behind if you die.

    That can include everything from ensuring your family can stay in their current home to debts or expenses you have now or expect to have in the future. Even if you don't have kids now, if you plan to have them in the future, don't wait to buy life insurance.

    "The most typical situation that triggers a life insurance policy is when a couple starts a family. But individuals undergoing other life changes, such as buying a house, changing careers, or owning a business, should also consider the benefits of life insurance as a means of helping to protect themselves and their family through the uncertainties of the future," says Tim Heslin, president of AIG Life US.

    What does life insurance cover?

    life insurance policy typically covers most types of death, including those caused by accidents, natural causes, illnesses like cancer and heart disease, homicide, and even suicide (if the death occurs after any suicide clause listed in the policy expires).

    "A life insurance policy typically provides replacement income for dependents, creates an inheritance for heirs, pays for final expenses like funeral, burial, and probate costs, and covers estate taxes so that heirs will not have to liquidate other assets," Friedlander says. "Also, some types of life insurance serve as a source of forced savings; that's because they create a cash value that, if not paid out as a death benefit, can be borrowed or withdrawn on the owner's request."

    Lacrecia Cade, president of Atlanta Life Insurance, says life insurance comes in handy for nearly everyone.

    "Often, it is used to pay off bills you may leave behind or take care of expenses for your children. It is a critical part of planning for what happens to your family if you die," says Cade.

    On the other hand, life insurance policies typically don’t cover deaths connected to:

    • High-risk activities like skydiving or bungee jumping
    • Criminal activity that causes the death
    • Suicide if it occurs within the contestability period (usually the first two years of the policy's effective date)
    • Fraud
    • Lapsed policy caused by unpaid premiums

    What are alternatives to life insurance?

    A life insurance policy isn't your only option if you want to provide a financial cushion for your survivors. Additional or alternative strategies to consider include: Should you consider life insurance as an investment?

    While it’s technically not an investment vehicle like a stock, bond, or mutual fund that can grow or decrease in value over time, a term life insurance policy can be considered as an investment of sorts. Term life is an asset that will help secure the financial well-being of your survivors.

    Unlike other types of investments, your predefined death benefit won’t decrease as long as the term life policy stays in effect, which means you can count on a specific return on your dollar if you pass away.

    A whole life policy, by contrast, has a true investment component because it can include an equity-like component referred to as cash value. Whole life insurance policies that accumulate cash value have a specified interest rate that’s credited each year, which compounds over time, accumulating a cash reserve that can be accessed for various purposes.

    Whole life policies classified as "participating" provide the possibility of receiving policy dividends, which represent a portion of the insurance company's profits paid to policyholders (paid at the discretion of the life insurance company without any guarantee). A dividend may be taken as cash, or a policy may offer several other ways the dividend might be used, such as to reduce current premium payments.

    A whole life policy's death benefit can also increase over time when your "paid-up additions" option is selected for the dividends or when your cash value exceeds the death benefit.

    Another investment-like form of life insurance is a universal life permanent policy, which also includes a cash value account that typically earns a money market rate of interest. The cash value may rise based on the performance of assets within your account and per the declared crediting rate (which the insurer can increase or decrease at its discretion).

    If you desire a policy that performs even more like an investment on the stock market, consider a variable life insurance policy, which combines death protection with a savings account that can be invested in money market mutual funds, stocks, and/or bonds that you choose.

    Here are how other strategies to life insurance work and their pros and cons.

    Investing in stocks, bonds, or other commodities via retirement accounts or by purchasing shares directlyYou may be able to get a much higher return on your dollar, without being required to die, and grow your wealth significantly over timeUnlike a term life insurance policy, investing is risky; any investment can lose value/money
    Accidental death and dismemberment coverageThis policy may be less expensive than a traditional life insurance policyThis only covers deaths for certain types of accidents but doesn't cover death from illnesses or natural causes
    AnnuitiesThese function like savings accounts and can pay you income reliably during your life and into retirement and later pay your loved ones upon your deathAnnuities may charge expensive fees compared to other investments; if you pass away prematurely, the value of an annuity is less
    Mortgage insuranceThis can ensure that your mortgage loan will be paid off if you die, default on your payments, or are not able to fulfill the loan's financial obligationsMortgage insurance is usually more expensive than life insurance; policies are designed to have a decreasing benefit as time passes, and your premium will not decrease correspondingly
    Savings accountsYou can salt away extra money into this account to be used by your survivors after your deathSavings accounts earn much lower interest than other types of bank accounts and will not grow your money as quickly as other options