How Much Life Insurance Do You Really Need?
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Even though most people may not want to dwell on it, death is inevitable. If you have loved ones who depend on your income, it is important to ensure that you have the right financial resources in place, including life insurance.
Life insurance can help pay off lingering debts, cover burial and funeral expenses, and make managing daily living expenses less of a burden for those you leave behind.
A major part of choosing a life insurance plan is to determine how much money your dependents will require. Choosing the amount your policy pays if you die (face value) depends on some factors and the minimum coverage you need might be different from what someone else needs.
Financial experts recommend that you purchase 10-15 times your annual income in coverage, but your personal number may be lower or higher. Here are some important factors to consider while choosing a minimum amount of life insurance:
Debt
Life insurance can be used to pay off outstanding debts, including mortgages, student loans, personal loans, car loans, and credit cards. Your policy should include enough coverage to pay any of these debts off in full.
For example, if you have a $4,000 car loan and a $200,000 mortgage, you’ll need at least $204,000 in your policy so that your debts are covered. Don’t forget to factor in the interest. You should take out a little more to settle any extra charges or interest too.
Income Replacement
Replacing income is one of the biggest factors of life insurance. For example, if you bring in $40,000 a year and are the sole provider for your dependents, you will need a policy payout that’s enough to replace your income along with a little extra as protection against inflation.
If you assume that the lump sum payout of your policy is invested at 8%, you’ll need about $500,000 in your policy just to replace your income. While this isn’t a set rule, adding your annual income back into the policy (in this case $500,000 + $40,000 = $540,000) is a pretty good guard against inflation.
You can start shopping around once you determine the required face value of your insurance policy. You can estimate the amount of insurance you need online.
Insuring Others
You may wonder if you should insure the other people in your life who are important to you. A rule that most people follow is to insure only those people whose death would mean a financial loss to you. For example, when an income-earning spouse dies, it creates both financial and emotional losses. In such a situation, use the income replacement calculation with his or her income.
This also applies to those business partners with whom you share a financial relationship. For instance, consider someone with whom you have co-owned property or shared responsibility for mortgage payments. Consider getting a life insurance policy for this person, as this death will have a great impact on your financial situation.