How Much Life Insurance Do I Need?

If someone depends on you financially, chances are you need to have life insurance. Life insurance policies come in many shapes and sizes but the question comes down to, how much life insurance do you actually need?

4% rule

4% represents the amount of income that a lump sum of money can produce. For instance, if you leave your partner $1 million of life insurance, that will produce about $40,000 of annual income for the rest of their life. Just to note, this assumes the income will grow with inflation each year and your partner will have a low chance of ever running out of money.

If you were to die tomorrow, how much income would your partner need in order to maintain their standard of living? Now multiple that number by 25. That’s how much TOTAL money you need to leave your partner in order to provide for them financially. Included in this total are your investment accounts, savings, and retirement plans. I wouldn’t include your home however since it is hard to get income out of the value of your home.

Example

Let’s say your partner needs $100,000 of annual income to maintain their standard of living. You have $500,000 in your 401(k) and $500,000 in an IRA.

$100,000 * 25 = $2,500,000

Savings = $1,000,000

Total Insurance Needed = $1,500,000

That’s a lot of insurance

$1.5 million can seem like a lot, but remember that it will only produce around $60,000 of income. Your $1 million in savings will produce the other $40,000. Does that mean you should run out and buy a $1.5 million policy? Not yet… There are a couple of other things to consider.

Can your partner earn money?

If your partner has the ability to earn $50,000 of income, then you may not need to leave them enough to produce $100,000. The partner’s ability to earn an income will significantly reduce the amount of insurance you need.

Do you want to provide for the rest of their life?

Someone once told me I didn’t need life insurance because my wife was young and pretty, so she would remarry quickly. Although highly offensive, it is appropriate to ask yourself if you need to provide income for their entire life, or just long enough for them to get on their feet and hit the reset button after you are gone.

At the very least, you want to leave enough money (which may include life insurance) so that your partner isn’t worried about how to pay the bills after your death. The more money you are able to leave will help protect them for a longer period of time. This has to be balanced however with the cost of the life insurance today.

Looking at how much life insurance you have, do you think need to get more? Do you possibly have too much? How are you deciding how much insurance to have? Feel free to share in the comments section!

Alan Moore is a fee-only financial planner and founder of Serenity Financial Consulting in Shorewood WI. Follow him on Twitter @R_Alan_Moore. You can contact him at alan@serenityfc.com, 414-455-5313, or visit his website at www.SerenityFC.com. Want more education? Download your free guide to the “10 Easy Steps To Securing Your Financial Future Today.”