Q&A: How do we know if we need more life insurance?

QUESTION

It’s been years since we bought our first life insurance policies, and so much has changed since then. How do we know if we have enough or whether we need more?

ANSWER

Let’s first review what a life insurance policy even is. At its core, life insurance is a contract between you and an insurance provider. In exchange for payments called premiums, the insurer agrees to pay your designated beneficiary a sum of money, called a death benefit, if you die. The main purpose of life insurance is to provide your dependents with financial assistance to cover expenses like funeral costs, outstanding debts, and day-to-day living expenses. Generally, people purchase life insurance individually or receive it as an employee benefit at work.

This is a great place to disclose, I don’t sell life insurance anymore. I did for a period of time, but I don’t now. Though I’ve got a broad base of knowledge regarding life insurance products, just know, I have absolutely no skin in the game regarding what you buy. That being said, life insurance is a cornerstone of financial planning. You’ve got to make sure your loved ones are protected should you die unexpectedly, but shopping these products can expose you to people trying to sell you coverage you don’t need. Going in with this knowledge will help.

So, let’s examine the main reasons you might need more life insurance coverage.

Your family dynamics have changed. Significant life events such as marriage, the birth of a child, or assuming responsibility for an aging parent can drastically increase your financial obligations. If you purchased your current coverage prior to these changes taking place, it's likely time for you to reassess. 

You’ve substantially grown your income. As your income grows, your standard of living tends to grow, too. Therefore, if you purchased insurance when your income was substantially lower than it is today, there’s a very good chance that it won’t cover your family’s current lifestyle.

You've acquired more debt. Buying a home, starting a business, or taking on personal loans increases your financial liabilities. Life insurance is designed to protect your loved ones from the burden of your debts. So, if you’ve taken on greater debt from when you originally purchased your coverage, you are going to want to make sure you have more coverage in place.

Inflation. Since the value of money constantly fluctuates, coverage that seemed sufficient a decade ago might not hold the same value that it does today. Take another look with this in mind.

Now that we understand the main reasons for obtaining additional coverage, let’s broadly discuss how much and what kind of coverage you should consider. 

Most basic calculations for determining life insurance coverage have you multiply the value of your current earnings by the number of years you plan to work. This is called the human life value approach, and it’s a good starting point for figuring out what you might need. For example, according to Guardian Life, if you’re between the ages of 18 and 40, you’d multiply your earnings by 30 to arrive at an appropriate amount. And if you’re between the ages of 41 and 50, you’d multiply by 20. It’s a quick and easy way to understand how much insurance you should have in place at any given time.

Another method for calculating your insurance needs is the DIME approach, which takes into account both future debts/costs and earnings. It’s calculated by tallying up all your current debts, future income, outstanding mortgages and anticipated college education costs. This method is a bit tricker, because you’ll need to assume how much of your income your family will need and how long they will need it, including what the cost of college will be in the future. But it’s a more tailored approach, as well.

Generally speaking, there are two types of insurance policies to choose from: term and permanent. Term insurance will provide coverage for a set period of lime, such as 10, 20, or 30 years, while permanent coverage will cover an insured for their entire life. For the vast majority of people, term insurance will be the way to go, because of its affordability and simplicity. Since the period of coverage is certain, it’s an easier product for insurers to price. In some cases however, permanent insurance can make sense, but the additional cost is usually a burden for most families, and the need for lifelong coverage is typically few and far between because most policies don’t make it to the insured’s death. 

Once you determine how much more insurance you need, I highly recommend obtaining quotes for term coverage from a fee-only financial advisor who works with independent insurance agencies. For DIY’ers, Policygenius is a leading website for buying a policy online. With an understanding of costs, consider applying for an additional policy or replacing your existing coverage depending on which approach is more cost effective. Be sure not to cancel any existing policies until new coverage is placed in force.

Life insurance is never a fun topic to discuss, but it’s still an indispensable component of comprehensive financial planning. Changes in family dynamics, income levels, debt, and inflation can significantly impact your life insurance needs, necessitating periodic reviews and adjustments to your coverage. Remember, the goal is not just to have life insurance, but to have adequate coverage that aligns with your evolving life stages and financial goals, ensuring peace of mind for you and your loved ones.

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