If you've been reading LearnVest for any amount of time, you've probably realized by now that life insurance—which gives you a financial safety net if you or your spouse dies—is important. Really important.
Like life-and-death important.
(Need convincing? Read this heartbreaking story from a daughter or the five ways that life insurance can save your family. We on the same page now? Good.)
After you decide that you need life insurance, the next question should be: How big of a one-time payment would you need? Is $50,000 enough? $500,000? A million?
The magic number that will bring you and your family peace of mind is different for everyone. But there are some ways to figure it out. Hint: $50,000 is probably not enough.
We asked LearnVest certified financial planner Rachel Sanborn to walk us through how she would advise a client on picking the right amount of life insurance. You're about to get professional advice. For free.
(P.S. Because most people would benefit most from term life insurance, we're assuming you're planning for a one-time payout in case of a death. To see the instances in which you would want whole life insurance—which acts more like an investment vehicle—read our life insurance guide.)
Who Should You Insure?
Your first thought might be just to insure the working spouse and skip insuring the stay-at-home parent—after all, a SAHP doesn't earn any money. But you'd be missing a crucial aspect: If one partner passed away, the surviving partner would probably have to pay for childcare, which can be equal to a small salary in itself!
RELATED: Life Insurance 101
What if both spouses are working? Again, you'd be forgiven for thinking that if one passed away, the surviving partner could live and support the family on one salary. Not really. For example, maybe one spouse contributes more than the other. Or if you split childrearing expenses, how would the surviving partner come up with the other half?
The only situation in which you wouldn't insure a partner would is if all the money that person earns goes exclusively to lifestyle choices and not to raising the kids, paying off debt or subsidizing shared expenses. But, even then, you'd still need to cover funeral costs.
So if you're married, you'll probably go through this coverage calculation twice—once for your own coverage and once for your partner. We'll walk you through that crucial calculation in five steps.
Step 1: Talk With Your Spouse
The most important thing to do before you start talking numbers on your own coverage is to get your partner involved. "The policy you take out on yourself is really for your spouse and vice versa," Rachel says. "The person who's going to be the beneficiary should be very involved in making those decisions." So sit down with your partner and do the math together on your own coverage.
Step 2: Follow a (Very) Simple Rule of Thumb
Rachel says that seven to ten times your salary will normally be adequate for life insurance. But this quick math misses some crucial nuances. For example, how do you decide seven to ten times a stay-at-home parent's hypothetical salary? Or let's say that your family has major outstanding debts.
Bottom line: If you recognize that you'll only get around to acquiring life insurance if the math is super simple, use this rule of thumb. But if you want coverage that's tailored to your family and life, read on for a more detailed breakdown.
Step 3: Decide How Many Years of Coverage You Will Need
"How many years of income do you or your spouse want replaced, so you can get back on your feet?" Rachel asks clients. Again, the key here is to be realistic and wise about what your spouse will need. Maybe he or she will do best throwing themselves into work right away. Perhaps your partner will need to go back to school. Or maybe your spouse wants to continue to stay at home and raise the kids. There's no right answer.
Once you have that number, multiply it by this number ...
Step 4: Which Salary Do You Need to Replace?
If you have a set yearly salary that your family relies on entirely, this is an easy number. But there are other scenarios:
- You're a stay-at-home parent. Do some research into the cost of yearly childcare in your area, plus factor in such chores as housecleaning, as well as a higher cost of food if your spouse will be too busy (or shellshocked) to cook for a while. That's your "salary" to replace.
- You have a variable income. Look at your tax return from last year to see what you earned. If it was enough, that's your salary. If it was tight, be generous with your number.
Related: How to Find Good Term Life Insurance
Step 5: Add These Things Into Your Figure
There are some other large expenses that you should consider when drafting your policy:
The average funeral now costs over $7,000, although it can go much higher, depending on the casket and the size of the service, among other things.
Are you making payments on a mortgage, student loan, car loan or any other loans? A life insurance policy should help your surviving spouse and/or family pay down "anything that wouldn’t get written off" if the borrower died, Rachel says. (Note: Federal student loans are discharged if the borrower dies, but private loans usually aren't.)
Will your spouse need to go back to school to prep for a return to the workforce? In this case, life insurance should include funds for tuition, plus childcare, so your spouse can concentrate on classes.
If you're currently saving for college (or plan to), get the price of tuition covered, too. Rachel suggests taking into account your current children, as well as kids you are still planning to have. You don't want to go through this process again in two years, do you?
Then you need to decide how much you'd cover, from two years at a community college to four years at a private university. (FYI: In 18 years, it's estimated that a private, four-year university will cost over $500,000.)
If you were to pass away, your spouse and your family could benefit from regular therapy to deal with the loss, which is pricey. You might also benefit from therapeutic activities, plus a vacation or two.
A life insurance payout isn't about putting a value on your life or making your family rich. It's about making sure that they have everything they need when you're gone to live full, happy lives.