How Much Life Insurance Do You Need?

To figure out how much life insurance you should purchase, consider how much money your family will need in order to live comfortably after you're gone. If your family is no longer receiving your income, how long could they continue to live in the style they are used to? If you are committed to ongoing expenses, such as college tuition or a mortgage, how long could your family continue to make those payments without your regular income? By considering how much money your family will need to live, you can determine how much life insurance you should buy.

Capital Needs Analysis

A Capital Needs Analysis is a tool used by insurance brokers and financial planners to determine how much life insurance you should buy. The basic equation of a Capital Needs Analysis determines the gap between the amount of annual income your family will have without your income and your family's immediate and ongoing annual expenses. By taking inflation into account, you can determine the size of the financial gap and purchase that amount of insurance.

To complete a basic Capital Needs Analysis, consider the following questions:

  • How much income will your survivors need each month? This total should include costs such as food, clothing, housing, education, transportation, child care, and other costs of living. Multiply the total number by 12 to get an estimate of annual income needs.
  • What is the difference between your survivors' projected annual income and how much money they will need if you should die? From the amount calculated in the question above (the amount of income your survivors will need), subtract your survivors' projected annual income, which includes annual salary, income from interest and investments, income from benefits (unemployment, Social Security, disability, etc.), and other sources of income. This number is known as the "annual shortfall."

To determine how much insurance you need, begin by multiplying the annual shortfall by 6% (0.06), a conservative accounting for inflation. To this number, add any lump-sum expenses that your survivors will need to pay for, such as college tuition, a mortgage, and debts (medical bills, credit card debt, funeral expenses, etc.). The total you calculate here is roughly the amount of insurance you will need to purchase.

Using life insurance calculators

Many websites and insurance companies offer online life insurance calculators that claim to determine how much life insurance you should purchase. Many of these calculators use similar algorithms, and you should get similar results from a number of different calculators. While online life insurance calculators can be helpful, they usually fail to offer the kind of transparency that many people value when making purchases of this significance. It may be a good idea to use a number of different online life insurance calculators to get a ballpark sense of the amount of insurance you should buy, and also speak with a licensed life insurance broker.

Talking to a life insurance agent

A licensed life insurance agent can usually help you understand how much life insurance you need in terms you can easily understand, can help you figure out the type of life insurance that best meets your needs and situation, and can help you find insurance at a good price (or "rate"). While the concept of life insurance is not necessarily complex, in practice life insurance can be incredibly complicated. Figuring out how much of what types of insurance you need can be a challenge, and making sure that the policy you're purchasing is the best policy for you and your situation can be difficult to determine without the help of a professional. If you are thinking about working with a life insurance agent, be sure to read our article How to Choose a Life Insurance Agent.

If you're looking to purchase life insurance, use our resource Get Help Finding the Right Life Insurance.

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