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ife insurance is a critical component of a comprehensive financial plan. However, the journey towards deciding the amount of life insurance to acquire often elicits divergent views. This article seeks to dissect the topic and shed light on the amount of life insurance you should ideally have.
A Simple Approach: The 10X Rule
One of the simplest ways to estimate the required life insurance cover is to multiply your annual income by ten. Known as the 10X rule, this simplistic approach, though easy, fails to capture some key variables that could significantly impact the required life insurance cover.
Digging Deeper: Debts, Desires, and Dependencies
A holistic approach requires factoring in your debts, specific monetary goals, and the potential income for your beneficiaries. Given these parameters, your life insurance might need to be as high as 20 times your annual income or more. Factors such as existing loans, the intended purpose of the insurance amount (e.g., providing an income for the beneficiaries), and your financial landscape collectively influence this figure.
The Purposes and Perks of Life Insurance
Life insurance is not a one-size-fits-all solution, and its purpose can vary greatly. It might be meant to pay off a significant debt, fulfil a lender's requirement, enable a business partner to buy out the surviving spouse's business interest, or secure the financial future of a family after the breadwinner's demise.
One vital perk of life insurance is that in most cases, the death benefit is tax-free. Despite this, it may require a hefty sum (say, $1,000,000 or more) to ensure that the surviving family members maintain a semblance of the lifestyle they were accustomed to, especially if the payout is intended to last for an extended period.
The Real Value of a Non-Working Spouse
An often overlooked factor is the economic value of non-working spouses. The work they do in managing the household and caring for children can amount to significant costs if they were to suddenly be absent. It may make sense to get a life insurance policy worth $250,000 or more on their lives to cover these costs.
Estate Planning and Life Insurance
For those with sizable estates, life insurance plays a pivotal role in estate planning. A large life insurance policy can be held in an irrevocable trust to effectively cover estate taxes upon the death of the insured person.
Deciding the amount of life insurance cover you need is a highly personal decision that depends on various factors, including your income, financial obligations, and long-term financial goals. Consulting with a financial advisor can help you make an informed decision that aligns with your financial situation and goals.
You may hear different things about the amount of life insurance that you need. An easy way some suggest is to take your annual income and multiply it by 10.
But that doesn’t take everything into account, such as debts, specific things you want the money to do, or a safe withdrawal rate to give your beneficiaries an income that you want them to have if something happens to you. The right number could be more like 20 times your annual income, but it all depends on the purpose of the money and your financial situation.
The amount of life insurance necessary to do what you want it to do is usually a little more than people think. With term insurance, in particular, the price per thousand dollars’ worth of coverage is low enough, generally, that it is affordable to get large amounts of coverage.
It depends on the purpose of the insurance. It could be that it is meant to pay off a certain amount of debt, and could even be required by a lender. It could be that it’s intention is to allow a business partner to buy out the business interest of a surviving spouse. It could be that the money is meant to provide for a family after a breadwinner is gone.
Keep in mind that in most cases the death benefit will be completely tax free.
Even with that bonus, it may take $1,000,000 or more to give the surviving family members even a shadow of the lifestyle they were accustomed to before the death of the breadwinner, if the money is meant to last a very long time.
Many people just say, “I guess my spouse will have to remarry or work, because I’m not paying for them to live off a trust fund the rest of their lives.”
It all depends on the person.
Speaking of spouses, even non-working stay-at-home spouses have an economic value to a household, and it may make sense to get $250,000 or more of life insurance on their lives in order to pay for the kind of work that the spouse currently does for free, such as taking care of the house and shuttling kids to soccer practice.
Estate planning may call for a large life insurance policy to be held in an irrevocable trust, and to essentially pay for the estate taxes upon the death of insured person.
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