How Much Life Insurance Do I Need?

The amount of life insurance you decide to purchase depends on your anticipated final expenses and your family's projected monetary needs in the future.

In most cases, if you have no dependents and enough money to pay your final expenses, you do not need any life insurance.

However, once you have dependents you should buy enough life insurance so that, when combined with other sources of income, it will replace the income you now generate for them, plus enough to offset any additional expenses they will incur replacing services you currently provide (for example, if you do the taxes for your family, the survivors might have to hire a professional tax preparer).

Your family might also need extra money to make some changes after you die. For example, they might want to relocate, or your spouse might need to go back to school to be in a better position to help support the family.

Most families have some sources of post-death income besides life insurance. The most common source is Social Security survivors' benefits. Many also have life insurance through an employer plan, and some from other affiliations, such as an association they belong to or a credit card. Although these sources might provide a significant income, it is rarely enough.

A multiple of salary?

Some experts recommend buying term life insurance or whole life insurance equal to 20 times your salary before taxes. If the benefit is invested in bonds that pay 5 percent interest, it would produce an amount equal to your salary at death, so the survivors could live off the interest and would not have to "invade" the principal.

While this formula is a useful starting point, it does not take inflation into account. It also assumes that one could assemble a bond portfolio that, after expenses, would provide a 5 percent interest stream every year. But assuming inflation is 3 percent per year, the purchasing power of a gross income of $50,000 would drop to about $38,300 in the 10th year. To avoid this income drop-off, the survivors would have to tap into the principal each year. And if they did, they would run out of money in the 16th year.

The "multiple of salary" approach also ignores other sources of income, such as Social Security survivors' benefits. These benefits can be substantial. For example, for a person who had been earning a $36,000 salary at death ($3000 a month), maximum Social Security survivors' monthly income benefits for a spouse and two children under age 18 could be about $2,300 per month, and this amount would increase each year to match inflation.

In this example, the survivors would need life insurance to replace only $700 per month (adjusted for inflation) of lost income; Social Security would provide the rest. These survivors would need life insurance to replace about $1,150 per month (adjusted for inflation) once the non-working surviving spouse has only one child under 18 in her care, and the surviving nonworking spouse would have to replace the entire $3,000 (adjusted for inflation) when the youngest child turns 18.

Bottom line: the amount of life insurance you need varies according to your financial, family and marital circumstances, but once you have dependents, you definitely need insurance coverage. It is probably best to seek the advice of a qualified insurance agent when you are ready to ask about getting a life insurance quote.

This article adapted from information provided by the Insurance Information Institute .