Life Insurance: How Much Do You Need?

It may seem like a daunting question as it's a topic nobody wants to think about. Life insurance is more expensive the older you are, so getting things in place as early as possible is the best way to ensure you will pay less over the long run. However, you shouldn't rush into buying the first policy you see. Your level of insurance cover should be carefully considered from the outset to ensure it is suitable for your circumstances.

Here are some practical tips for calculating what is the right amount for you. 

How much debt do you have?

First, you should figure out how much debt you would have if something were to happen to you. This includes your mortgage, car loan, and other debts. Most people would not like to pass on debt to their next of kin, so having this covered should be a minimum.

What is your household income?

If your income was to all of a sudden stop, how would this impact your family? For many families, the loss of a primary income source would negatively impact their lifestyle. Providing a lump sum that would replace this income over a few years would reduce the impact of this shock. Total up your annual average income and multiply it by the number of years of income you want to provide. Add this to the total debt figure from point 1. Around 10 years of income could be a good starting point and can be adjusted based on your budget.

How much life insurance do you have from other sources?

Many people have some form of life insurance provided by their employer. You need to check the amount your employer covers and the specific circumstances they will pay out. For example, some employers only cover accidental death at work. Others will offer more comprehensive coverage so long as you are employed ('in service') for that company. In many cases, your employer's coverage is enough on its own. Subtract your employer's coverage from the total in point 2.

How much insurance do you need for the future?

This can be tough to answer as nobody has a crystal ball. A good place to start would be to account for any significant expenses you are sure you want to provide for your family. A typical example is future education costs for children or later life care for elderly dependents. If this subtotal from point 3 is not enough to cover the projected future expenses, add the difference to the total.

Don’t buy more than necessary

The insurance providers have an incentive to offer you more insurance than you might need; after all, higher insurance cover and extra features mean higher premiums. It may feel comfortable knowing you have a large amount of insurance coverage. If you do buy more than you need, there is an opportunity cost where the money could have been used elsewhere for investment or just enjoying more of life in the present. A carefully thought out insurance plan will provide you with no more and no less than you need.

Review often

It is essential to review your level of cover regularly to ensure it is still relevant to you. A life transition can trigger a change in your insurance needs when there is a life transition, such as marriage, divorce, or the birth of a new family member. The same with any direct financial change such as an increase in salary or changing jobs. A common misstep is when people change jobs, the cover offered by their new employer can be much less than their previous. Which leaves a significant gap in their cover.

Reviewing your insurance needs every year is a sensible starting point. This will give you peace of mind that you will always be suitably covered.