In this lesson, you will learn how to determine life insurance needs and how to purchase a policy. Specifically, this lesson will cover the following:
1. Life Insurance Needs
By now, you’ve probably wrapped your head around the different types of life insurance from the last lesson, and maybe you’re even starting to feel like a bit of a pro. But here’s the thing: Knowing the types of policies is only half the battle. The real magic happens when you figure out exactly how much coverage you need.
-
Think of life insurance as a financial safety net for your loved ones. But how big does that net need to be? Too small, and your family might struggle to make ends meet. Too big, and you’re shelling out cash for coverage you don’t really need (and let’s be honest, who wants that?). This step is all about striking the right balance—making sure your loved ones are covered without overpaying.
Imagine this: You’re gone (morbid, I know, but stick with me), and your family is left to figure out how to pay the bills, keep the house, and plan for the future without your income. It’s a daunting thought, right? That’s why determining the right amount of life insurance is so important. Whether you want to ensure that your spouse can pay off the mortgage, your kids can go to college, or your family can maintain their standard of living, the right coverage is like leaving a legacy of financial peace.
Let’s walk through three practical and easy-to-understand methods to determine your life insurance needs. Each method comes with relatable examples so you can see exactly how it works in real life.
1: The Income Replacement Formula
The income replacement formula is the simplest and most commonly used method. The idea is straightforward—calculate how much money your family would need to replace your income over a significant period (typically, 10 to 15 years). This ensures that your loved ones can maintain their lifestyle and cover daily living expenses.
-
The Income Replacement Formula
Annual Income × 10 to 15 = Life Insurance Needs
-
EXAMPLE
Let’s say you earn $50,000 per year. Using the income multiplier:
- $50,000 × 10 = $500,000 (for 10 years of income replacement)
- $50,000 × 15 = $750,000 (for 15 years of income replacement)
In this case, you’d aim for a life insurance policy between $500,000 and $750,000.
This formula is simple and effective for general planning but doesn’t account for specific debts, mortgages, or future costs like college tuition.
2: The DIME Method
The debt, income, mortgage, and education (DIME) method goes a step further by breaking down your financial obligations into specific categories:
- Debts: Total any debts you owe, like credit cards, car loans, or personal loans.
- Income: Multiply your annual income by the number of years your family would need to replace it.
- Mortgage: Add the remaining balance of your mortgage.
- Education: Estimate the future cost of your children’s education.
-
The DIME Method
Debts + Income + Mortgage + Education = Life Insurance Needs
-
EXAMPLE
Here’s a breakdown for someone with a family and financial responsibilities:
- Debts: $25,000 (credit cards and car loan)
- Income: $50,000 per year × 10 years = $500,000
- Mortgage: $200,000 remaining
- Education: $100,000 for two kids’ future college costs
Total: $25,000 + $500,000 + $200,000 + $100,000 = $825,000
In this scenario, you’d need approximately $825,000 in life insurance coverage.
The DIME method is a great way to account for specific expenses, ensuring that nothing is overlooked.
3: Expense-Based Calculation
Expense-based calculation is the most customizable option. Instead of relying on general multipliers, you calculate coverage based on the actual expenses that your family would face. This includes everyday living costs, unpaid debts, future needs, and even final expenses like funeral costs. From this total, you subtract any savings or assets you already have.
-
Expense-Based Calculation
Income Replacement + Debts + Future Expenses + Final Expenses − Savings and/or Assets = Life Insurance Needs
-
EXAMPLE
Let’s calculate for someone with the following expenses and assets:
- Income Replacement: $50,000/year × 10 years = $500,000
- Debts: $225,000 (mortgage + other debts)
- Future Expenses: $100,000 (children’s college tuition)
- Final Expenses: $10,000 (funeral and medical costs)
- Savings/Assets: $50,000 (savings and investments)
Total:
- $500,000 + $225,000 + $100,000 + $10,000 − $50,000 = $785,000
In this case, you’d need a life insurance policy of about $785,000.
This calculation works well for families with specific financial goals and clear estimates of their future needs.
Which Calculation Is Right for You?
- If you’re looking for a quick estimate: Use the income replacement formula to get a ballpark figure.
- If you want a detailed, personalized number: Use the DIME method to account for all financial obligations.
- If you prefer precision: Expense-based calculation is the most accurate, especially if you have clear details about your family’s financial needs and current assets.
-
Meet Jaz. Jaz is a 36-year-old marketing strategist with one kid, a mortgage, and a few debts. She earns $75,000 annually, has $15,000 in savings, and wants to make sure her child is financially secure if something happens to her. Let’s break down Jaz’s situation and figure out how much life insurance she needs.
- Annual Income: $75,000
- Mortgage Balance: $200,000
- Debts: $10,000 (credit card and car loan)
- Child’s Future Education Costs: $50,000
- Savings: $15,000
It’s your turn to try your hand at these methods that determine life insurance needs. Remember to click the “+” button to see if you are correct.
Question 2: Use the DIME method to calculate her life insurance needs.Using the DIME method, Jaz can add up her debts, income replacement needs, mortgage, and child’s education costs:
- Debts: $10,000
- Income Replacement: $75,000 × 10 years = $750,000
- Mortgage: $200,000
- Education Costs: $50,000
Formula: $10,000 + $750,000 + $200,000 + $50,000 = $1,010,000
Jaz would need approximately $1,010,000 in life insurance to fully cover her debts, replace her income, and provide for her child’s education.
Question 3: Using expense-based calculation, estimate Jaz’s insurance needs.Using expense-based calculation, Jaz can account for all her family’s needs, subtracting her savings:
- Income Replacement: $75,000 × 10 years = $750,000
- Debts: $10,000
- Future Expenses (Education): $50,000
- Final Expenses: $15,000 (funeral and medical costs)
- Savings: Subtract $15,000
Formula: $750,000 + $10,000 + $50,000 + $15,000 − $15,000 = $810,000
Jaz’s total life insurance needs would be $810,000, considering her specific expenses and savings.
-
Here are some practical tips to help you calculate your life insurance needs.
- Be Realistic About Future Expenses: Consider inflation when estimating costs for things like college tuition or daily living expenses.
- Reassess Over Time: Your life insurance needs may change as your debt decreases, your children grow up, or your savings increase.
- Don’t Overestimate Assets: While savings and investments can reduce your coverage need, ensure that those funds are actually accessible in an emergency.
These three methods give you the tools to calculate your life insurance needs confidently. Whether you prefer a quick estimate or a detailed breakdown, the most important thing is ensuring that your loved ones are protected financially. Take the time to run the numbers and choose the method that feels right for your situation. Now, let’s take a look at how you purchase life insurance once you know your needs.
-
- Income Replacement Formula
- A quick estimate of how much life insurance you need by multiplying your annual income by 10 to 15 years to provide financial support for your family.
- Debt, Income, Mortgage, and Education (DIME) Method
- A detailed calculation that adds up your debts, income replacement, mortgage balance, and education costs to determine the total coverage needed.
- Expense-Based Calculation
- A precise method that calculates coverage by adding up your actual expenses (income replacement, debts, future costs, and final expenses) and subtracting your savings and assets.
2. How to Purchase Life Insurance
Buying life insurance can feel overwhelming, but the good news is that there’s a clear path to follow. With your coverage amount and type of policy already decided, it’s time to tackle the next step: purchasing the policy. Think of this like shopping for a major investment—your family’s financial security. Here’s a relatable look at the four main ways to buy life insurance, along with their pros and cons.
Option 1: Through an Employer
For many, employer-sponsored life insurance is their first experience with coverage. It’s convenient, it’s often affordable, and it may even be free. However, it’s worth noting that this coverage typically offers only a modest safety net—usually 1–2 times your salary—and isn’t portable if you change jobs.
- Pros: Convenient, low-cost, or free
- Cons: Limited coverage and not transferable if you leave your job
This option is a good start, but for many families, it’s like a sample size—enough to get a taste but not enough to meet their full needs.
Option 2: Through an Insurance Agent or Broker
If the idea of navigating life insurance feels like assembling furniture without the manual, working with an agent or broker could be a lifesaver. These professionals can guide you through your options and compare policies from multiple companies, helping you customize your coverage.
- Pros: Personalized advice and access to multiple insurers
- Cons: Some agents may prioritize policies with higher commissions
This option is great if you want tailored guidance, but do your homework to make sure you’re getting advice that’s in your best interest.
-
When it comes to finding a life insurance agent or broker, it’s hard to know where to start. Finding an agent or broker that is reputable and will work to put your needs first is always important. You can use sites like
Life Happens to find life insurance agents and brokers in your area. It’s a good idea to talk to a few different agents and brokers to find one that you feel most comfortable with.
Option 3: Online
For those who prefer to skip face-to-face interactions, online platforms offer a quick, no-pressure way to buy life insurance. You can compare quotes, complete the application, and, in some cases, even secure approval without a medical exam—all from the comfort of your couch.
- Pros: Fast, convenient, and often affordable
- Cons: Limited ability to ask questions or get personalized advice
Online life insurance works best for self-starters who know what they need or those who value speed and simplicity over in-depth guidance.
-
There are lots of online companies where you can shop for life insurance. A simple Google search will pull up many different options to choose from. A few places to search are
Policygenius,
Ladder Life, and
Ethos Life.
Option 4: Directly From an Insurance Company
Already know exactly what you’re looking for? Purchasing directly from an insurance company cuts out the middleperson. You’ll handle most of the research yourself, but the process is typically straightforward.
- Pros: No middleperson and a simple application process
- Cons: Requires more upfront research and decision-making
This option is ideal if you like having full control of the process and are confident in your ability to evaluate policies.
Choosing the right way to buy life insurance depends on how much help you need, how quickly you want coverage, and your comfort level with doing your own research. Whether you go through your employer, work with a broker, shop online, or buy directly, the goal is the same: securing a policy that fits your needs and budget. Remember, life insurance isn’t a one-size-fits-all purchase, so take your time and make a choice that brings you peace of mind.
-
Before you dive into purchasing your policy, here are a few tips to make the process smoother and more cost-effective:
- Start Early: The younger and healthier you are, the lower your premiums will be—so don’t wait.
- Shop Around: Just like shopping for a car, comparing quotes from multiple insurers will help you find the best deal.
- Consider a Medical Exam: Policies requiring medical exams often have lower premiums because the insurer has a clearer picture of your health.
- Be Honest: Accurately disclose your health and lifestyle to avoid future claims issues.
- Review Your Policy Regularly: Major life events—like getting married, having kids, or buying a home—might mean you need more coverage.
With these tips in mind, you’ll be well on your way to choosing the right policy and securing a strong financial foundation for your loved ones.
Purchasing life insurance may seem daunting, but by breaking it down into manageable steps and exploring your options, you can make a decision that fits your needs and gives your loved ones the protection they deserve. Whether you choose to go through your employer, work with an agent, shop online, or buy directly from an insurer, the most important thing is taking action.
Life insurance is more than just a policy—it’s a promise to the people you care about the most. It’s the reassurance that no matter what happens, their future is secure. Take your time, do your research, and don’t hesitate to ask questions. The peace of mind you’ll gain from knowing that your family is financially protected is worth every effort.
-
- Employer-Sponsored Life Insurance
- Life insurance provided through your job—often free or low-cost—that offers basic coverage (typically, 1–2 times your salary) but isn’t portable if you leave the company.
In this lesson, you learned all about determining your life insurance needs, including the three types of methods you can use to do so. You also now understand how to purchase life insurance to meet your needs.
