What's the right amount of life insurance to have?
Obtaining life insurance can help your family manage financially after you pass away, but the payout amount can vary significantly. The coverage level depends on how much you're willing to pay in premiums, the type of insurance policy, and the life insurance provider.
Some people might take out a policy with a relatively small coverage amount, like $25,000, whereas others might take out a multi-million-dollar policy. There is a rule of thumb to obtain life insurance coverage that's worth approximately 5-10 times your annual salary, but even that might not be prescriptive enough for your situation.
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What's the right amount of life insurance to have?
To come up with a life insurance amount that's right for you, consider the answers to the below questions.
Who depends on you financially?
Thinking about who depends on you financially can help you figure out the right amount of insurance to have.
If you have no dependents, for example, then you might decide to go with a smaller life insurance policy. Yet if you have young children, for example, then you might calculate what it would take to support them until they grow up. The more dependents you have, the more you'd generally want to have in insurance coverage.
And you might make choices like obtaining a term life insurance policy to afford higher coverage than you could with a whole life insurance policy if you're mainly trying to protect against a situation like passing away before your kids become adults.
If you have a spouse/partner, consider their needs as well. Even if they make a good living now, they might need additional support if you passed away, such as if they took an extended leave of absence from work to spend more time with your children. Although this might be a difficult conversation, consider calculating with your spouse what a comfortable life insurance amount would be to help ease their burden.
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What's your debt situation?
Another factor in calculating life insurance coverage is looking at your debt situation.
While your family generally isn't responsible for your debt, unless you and your spouse co-signed, for example, other assets in your estate might be used to pay off your debt, meaning that money then wouldn't be available for your family. So, you might want to take out enough life insurance to satisfy any debts.
Also, even if you're the only one listed on your mortgage, you might want to leave your family with enough money via life insurance to satisfy that debt so they can keep the home.
How's your financial health?
As much as you might want to protect your family, if you're struggling to make ends meet every month, then it might not make sense to stretch your budget further by purchasing a high amount of life insurance coverage. You generally want to make sure that you can keep paying the premiums for whatever life insurance amount you choose (though there are things like waiver of premium riders that can help protect you in case you can't pay premiums due to a disability, for example).
If you're in a strong financial position, the decision could go either way. You might be willing to buy more life insurance coverage to potentially leave your family with more money, as you don't have to worry as much about affording premiums. That said, you'll also want to weigh buying more life insurance against using that money for other savings and investments. You might prefer to build up assets on your own to pass on to your loved ones.
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What does your estate plan look like?
Lastly, consider what your estate plan looks like when determining life insurance coverage. You may want to include life insurance as part of your estate planning strategy to pass money on to heirs, with the exact amount depending on factors like your tax situation and personal wishes for leaving an inheritance.
For example, some wealthy families use life insurance to help cover estate taxes on inheritances. Or, you might simply envision leaving your children with a certain amount that makes you all feel comfortable.
The bottom line
Considering questions like these can help you come up with the right level of life insurance coverage. But try not to worry if you feel like you can't come up with the right amount. In many cases, you can change your life insurance policy, so if your circumstances change, you might be able to adjust your coverage. Or, you might decide to cancel your life insurance policy and take out a new one.
Ideally, though, you can figure out a good plan ahead of time and gain the peace of mind that can come with sufficient life insurance coverage. Keep in mind that speaking with a trusted advisor can help you make these calculations if you're having trouble figuring out what to do on your own.
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