How Much Term Life Insurance Do You Need?

You’re probably assuming that I know the answer to the post title, but unfortunately I don’t have an exact answer.  Like most personal finance issues, it really depends on your current situation.

I believe that life insurance is a means of protection, not a means of making someone rich.  To clarify, term life (not universal life insurance) should be used to protect the people dependent on your cash flow.  On top of that, I feel that people should work towards building their asset base so that they eventually won’t need insurance.  That’s why term life works so well.  It covers you when you NEED the insurance while you’re young, but 20 years down the road hopefully your debt will be low along with enough assets to cover the needs of your dependents (if you have any at this point).

Personally, with both my wife and I working with decent salaries, we don’t “depend” on each other for cash flow.  If one of us were to pass away the only real financial pain we would face would be our biggest debt, our mortgage.  So in my specific situation, I would be comfortable with getting enough term insurance to cover the mortgage.

When we do have children, the whole insurance picture changes drastically.  Now, not only do we need enough term life to cover our debts, but now we need to replace income to raise a child in case one of us passed away.  So how much do we need to cover a child?  Realistically, assuming that the insurance covers all debts, one of us should have no problem raising a child (financially speaking).  However, what about larger future purchases like college/university or the cost of a nanny care to help out with single parenthood?  Perhaps enough  insurance (on top of debt payment) to put a lump sum into a RESP (you can do this with the new RESP rules), and a bit extra to cover other child are expenses.

In conclusion, life insurance is meant to help reduce the financial burden faced by the beneficiary.  With that in mind, you’ll need a lot less life insurance than what most insurance reps will recommend.  However, every situation is different.  If you have dependents, sit down with your spouse and have a chat about the worst case scenarios.  How much would you need to minimize the financial burden in case one spouse passed away?

If you want to get some comparison quotes on term life and auto insurance, check out Kanetix.  I’m all about comparison shopping, and Kanetix provides a free insurance comparison service for both Canadians and Americans.

What are your thoughts on the amount of life insurance needed?

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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11 years ago

I’ve heard that a good approximate number for insurance is 10x your annual income. Lets say you make $100k/yr. You took out a $1M policy and you owed
$400k on your Mtg and other liabilities. When the policy paid out your significant other could pay off the debt and invest the $600k remaining. Assuming a conservative return of 6%/annum. The interest made would be $36,000/yr which the significant other could use to pay bills. It wouldn’t make them rich by any means, but it would definitely reduce their financial burden.

If I were to pass away I don’t want my family to be put in a situation where they have to sell everything and lower their standard of living because i’m gone. If they decide they want to move or sell some of the assets then that is fine but they shouldn’t have to.

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11 years ago

[…] Insurance Ratio – As another pillar of personal finance, term life insurance is a must. The author explains how much life insurance you need at each age group.  To me, […]

12 years ago

Life insurance is not about need…its a want.

What do you want for your family in terms of income replacement?
What do you want for your family after suffering the loss of a parent?
What do you want to leave as a legacy for your children?
Etc. etc.

The only relevant question to answer is if you knew you were going to die tomorrow…how much would you buy?

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12 years ago

[…] Have enough term life insurance. […]

Term Life Insurance
12 years ago

As has been quoted ad nauseum, the standard metrics are 7 – 15 times annual salary, but paradoxically, be careful not to over-invest in any one policy. Shop around and you’ll be glad you saved the money down the road.

Life Insurance Calculator
12 years ago

One way to find an accurate estimate of life insurance to meet your needs is to use an online life insurance needs calculator.

By answering some questions about your particular financial situation, you get a much more accurate estimate, rather than by using the old 7-10 times your annual income approach life insurance agents used to use.

Determining our Life Insurance Needs I - Criteria | Million Dollar Journey
13 years ago

[…] the new home, we're going with term life insurance instead of typical mortgage life insurance.  Why? The reason being is that mortgage life […]

14 years ago

Gates, you have to keep in mind that in the US they pay estate taxes and are also charged taxes on ‘gifts’ to other people which prevents avoidance of the estate tax.

I don’t know the exact details but the bottom line is that while the scenario Evan describes doesn’t make a lot of sense in Canada, it does make sense in the US.


Man From Atlantis
14 years ago

Hi Gates:

Yeah, we probably are a little off target for the topic. Just a couple points.

There are some people who will never spend all their money and most often those people have incorporated businesses. This is probably why Evan mentioned the business.

If they don’t care about how much money they leave to the next generation then sure they don’t need insurance. What I find though, just like insurance needs change over time, people’s attitudes change. As people get older they think more about wanting to leave money to their children or grand children. True not everyone.

So back to how much insurance do you need. Unless you are going to be very succesful and not spend all your money stick with term and invest the difference. You can always use your home as an insurance policy – it pays out tax free – although you may take the tax free income from the house and spend that too.

As a side, there is no diffence between corporate and personal life insurance, just the way it is used. Plus it is cheaper to pay for it with corporate dollars.

Gates VP
14 years ago

OK, Evan & Man From Atlantis. I think that you’re crossing some wires here, or maybe just band-aiding the wrong problem.

Check the Universal Life links to get more details of how this works in Canada. I asked a lot of questions and Ed had a lot of answers, but long story short, when the last person dies and the wealth moves down it all get “cashed out” and any unpaid taxes are due.

The “family cottage” will incur capital gains taxes, and investments will be converted to cash and losses/gains claimed on taxes. These are all taxes you owed anyways but that were deferred in some way, not some new set of “estate taxes”.

So, to whit:
You cause a fire sale of assets that may or may not be worth that amount upon death, i.e. the New York Housing market just took a major hit….if you were to sell your “1,000,000? house it may only go for 800K (housing is down 20% on long island)

This would be great in Canada, the capital gains would be way lower and the kids would still have the place. (assuming they could cover for the tax)

Evan brings up two other points:
FT it is not always simple to sell the assets. Plus business owners spend their life creating something and there is often an emotional attachment to the business – They don’t want to lose it to taxes and they want their kids to take it over.

You’re not required to sell the assets, you’re just “cashing out”. If you have a home “valued at” 500k when you die, the kids pay your capital gains tax on the difference between the new price and the original and the house is theirs. But you should be able to cover the taxes on an unwanted item by selling that item. If you can’t sell the item then it has no value and can’t incur capital gains taxes.

As to business owners, that’s a completely different line. Personal life insurance has no relation to Corporate insurance, as nobleea mentions, that’s succession planning and has a scope way wider than some simple “what am insured for”. If people don’t want their businesses taxed to death, they’ve already incorporated and written the legal documents to ensure that succession is handled.

Really though Evan, what I don’t get is why you’re dying with 4 million dollars in the bank and kids not already taken care of? Is that money fully invested just ready to eaten by the income tax crows? If you have kids that need the money that stuff should already be hidden in trust funds or invested in corporations owned by the offspring or basically off the books. Bill and Melinda Gates aren’t going to pay $80 billion in estate taxes if they died tomorrow, so maybe some minding of business is in order here.

If you have 4 million and kids and you’re under 30 then maybe none of my ideas are valid. But if you have 4 mil, fully grown kids and you’re over 70 (or some reasonable dying age) then what the heck are you doing with 4 million in assets? By now everything relevant should be in the kids’ names (probably including your home) and you should be living off an annuity.

I mean maybe you’re somewhere in between (you 55 kids are 30, lots of investments), but if the 1.5 million is even relevant to the next generation, then you’re probably doing something wrong. Like what is that $1M on a home and $3M in stocks and bonds? If you want your kids to have money, why not just say: “Hey Son we’re buying a 500k business jointly and I’m spotting you the money. We’ll draft up the whole thing so that when I die, you get my shares at a deep discount.”