Monday, January 9, 2012

How much life insurance should you get?

Life insurance: it's one of the most important things any parent - or anyone who has loved ones depending on them - should have.  But how much should you get?

In my opinion, a wage earner should hold enough life insurance so that if that person were to pass away, the heirs could invest the insurance money conservatively and use the earned interest to replace the income of the wage earner.

Say a person earns $50,000 after taxes are withheld. That person would want to have enough life insurance so that the amount would gain $50,000 per year.  Depending on the risk level of your investment, you might earn 5% in a conservative bond fund, so you would need $1 million in term insurance in order to get $50,000 per year.   Or if you were to invest in stocks, you might earn 10%, so you would get $500,000 in insurance to get $50,000 per year.

So a good rule of thumb is to get 10 to 20 times your annual salary after taxes.  Can you get away with less?  Perhaps, if you also have other investments.  But term life insurance is pretty cheap, compared to the peace of mind you get from having it.

If you have some life insurance as an employment benefit, you can subtract the insurance amount from the amount you'll purchase on your own.  So if you want to have $500,000 in coverage, and your job gives you $100,000 of coverage, you'll only need to purchase $400,000.

And what about non-wage earners?  Stay-at-home moms should also get life insurance, because if a mom were to pass away, the dad would need to replicate the services she provides to her family.   You would need to calculate the replacement cost of the stay-at-home mom's services, then get 10 to 20 times that amount in insurance.

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