How Do I Choose a Coverage Amount for Life Insurance?
One of the most important decisions that must be made when shopping for life insurance is how much coverage to purchase. Determining the optimal level of death benefit can be a tricky decision, and there are no hard and fast rules when it comes to determining how much life insurance coverage is enough.
Fortunately, however, there are some guidelines that workers can use to determine how much coverage their families will need in the event of their deaths. When determining the best death benefit level one of the most important factors is the annual salary of the person being insured. Typically those who make a higher salary will require a higher level of life insurance coverage than those who make less money, but as with all guidelines there are some exceptions. It is also important to consider other factors, including how much the family spends on a monthly and an annual basis, the size of the family’s fixed expenses, the number of years remaining on the mortgage and so on.
Many financial advisors recommend that workers with spouses and families to support purchase a life insurance policy with a death benefit equal to between 20 and 30 times their annual salary. The midrange suggestion for many workers is 25 times annual salary. At first blush that can seem like a lot of coverage, but after some additional analysis the reason for this recommendation becomes quite clear.
Let’s consider a worker making an average salary of $40,000 per year. Let’s also assume that the worker has a wife and two small children who rely on him for their financial support. If that worker were to die unexpectedly it could take up to $1 million or more to replace that lost income. That assumes a withdraw rate of no more than 4%, a level recommended by many financial experts and based on historical returns for safe investments like certificates of deposit and U.S. Treasury securities. Withdrawing no more than 4% per year from the lump sum is one of the best ways to ensure that the money will last as long as it is needed.
When seen from this perspective, a death benefit of 25 times an annual salary of $40,000, or $1 million in coverage, does not seem so extravagant. Purchasing coverage equal to 30 times that salary can provide an additional cushion and help protect the survivors from periods of inflation and low investment returns.
Of course not every worker will need this level of coverage, and it is important to consider a number of factors before making a final decision. For example, families who have always lived well below their means may be able to get away with a lower death benefit, since not all of the worker’s annual income was spent. Those who have been diligent savers may also have built up their own nest egg – a nest egg that could be tapped to make up any shortfall left by a lower death benefit.
In the end, determining the optimal level of death benefit is a very personal decision, and one that every insurance shopper must make. Taking the time to sit down with a pen and paper – or a computer spreadsheet – can take a lot of the guesswork out of this important process. No matter what type of life insurance coverage is ultimately chosen, the most important thing is to choose a policy that provides the highest possible level of coverage at the lowest possible cost.
Play around with our life insurance calculator. Know that this is only an estimate and every scenario deserves a personal consultation.
Please call us so we can talk about your life insurance needs. 1-877-872-7071