Three life insurance rules of thumb

If you want to determine your existing life insurance needs quickly, the below rules of thumb systems can be an easy way to get a value. These systems are better than a random guess but often fail to account for essential parts of your financial life.
Use the calculator above to get a more refined idea of how much life insurance you need, then compare that value to these rule of thumb estimates.

Rule of Thumb No. 1: Multiply your income by 10

The “10 times income” rule doesn’t take a detailed look at your family’s needs, nor does it consider your savings or existing life insurance policies. And it doesn’t provide a coverage amount for stay-at-home parents, who should have coverage even if they don’t earn an income.
The value provided by the stay-at-home parent needs to be replaced if he or she dies. At a bare minimum, the remaining parent would have to pay someone to provide the services, such as childcare, that the stay-at-home parent provided.

Rule of Thumb No. 2: Buy 10 times your income, plus $100,000 per child for college expenses

Education expenses are an important component of your life insurance calculation if you have children. This formula adds another layer to the “10 times income” rule, but it still doesn’t take an in-depth look at all of your family’s needs, assets, or any life insurance coverage already in place.

Rule of Thumb No. 3: The DIME Formula

This formula encourages you to take a more detailed look at your finances than the other two. DIME stands for debt, income, mortgage, and education—four areas you should account for when calculating your life insurance needs.

Debt and final expenses: Add up your debts, other than your mortgage, plus an estimate of your funeral expenses.

Income: Decide on how many years your family would need support and multiply your annual income by that number.

Mortgage: Calculate the amount you need to pay off your mortgage.

Education: Estimate the cost of sending your children to school and college.
By adding all of these obligations together, you get a much more well-rounded view of your needs. However, while this formula is more comprehensive, it doesn’t account for the life insurance coverage and savings you already have. It also doesn’t consider the unpaid contributions a stay-at-home parent provides.

How to calculate how much life insurance you need?

Follow this general philosophy to find your own target coverage amount: financial obligations minus liquid assets.

Calculate obligations: Add your annual salary (multiply the number of years you want to replace income) plus your mortgage balance plus your other debts and future needs such as college and funeral costs. If you’re a stay-at-home parent, include the cost to replace the services that you provide, such as childcare. From that, subtract Liquid Assets such as savings plus existing college funds plus current life insurance.

Calculation example: To illustrate, let’s look at a fictional couple: Jason and Heather. They have two children, ages 2 and 5. Heather earns $75,000 a year, and Jason is a full-time stay-at-home dad. They have a $150,000 balance on their home mortgage, owe $16,000 on two car loans, and have $3,000 in credit card debt. Heather has group life insurance equal to double her annual salary, and Jason has none. Together, they have $20,000 in a savings account and $10,000 in their children’s college funds.
The couple decides they want 30-year term life insurance policies. By the end of the term, their children will be adults, their mortgage will be paid off in full, and, if they stick to a savings plan, the remaining spouse will have a retirement nest egg.

To calculate her life insurance needs, Heather would add her obligations

  • • $1.2 million for income replacement ($75,000 multiplied by16, the number of years before her youngest child graduates from high school).
    • $150,000 for the mortgage balance.
    • $19,000 for debt ($16,000 in car loans, plus $3,000 in credit card debt).
    • $200,000 for two children’s college educations.
    • $7,600 for final expenses — approximately the median cost of a funeral with a casket, according to the National Funeral Directors Association.

This totals $1,576,600. From this, Heather would subtract:

  • $20,000 in savings.
  • $10,000 in the children’s college funds.
  • $150,000 of group life insurance.

This means Heather should buy a $1.4 million ($1,396,600) term life policy.

Here’s how a calculation would work for Jason. His obligations would include:
• $100,000 to replace the childcare that he now provides until the children are teenagers.
• $150,000 for the mortgage balance.
• $19,000 for debt.
• $200,000 for two children’s college educations.
• $7,600 for final expenses.

This totals $476,600. From this, he would subtract $30,000 to account for the couple’s savings and their children’s college funds. His final estimated life insurance need is about $450,000.
Jason might also want to figure income replacement into his policy. The surviving parent might want to quit work to take care of the children for a few years — in which case, the stay-at-home parent’s policy should include income replacement, rather than child care costs, for those years.

Tips for Life Insurance Calculations

Keep these tips in mind as you calculate your coverage needs:

Rather than planning life insurance in isolation, consider the purchase as part of an overall financial plan. That plan should consider future expenses, such as college costs, and the future growth of your income or assets. Once that information is known, then you can map the life insurance need on top of the plan.
Don’t skimp. Fidelity Mutual Financial recommends buying a little more coverage than you think you’ll need instead of buying less. Remember, your income likely will rise over the years, and so will your expenses. While you can’t anticipate exactly how much either of these will increase, a cushion helps make sure your spouse and children can maintain their lifestyle.
Discuss the numbers with your spouse; that is what we advise at Fidelity Mutual Financial. How much money does your spouse think the family would need to carry on without you? Do your estimates make sense to them? For example, would your family need to replace your full income or just a portion?
Consider buying multiple, smaller life insurance policies, instead of one larger policy, to vary your coverage as your needs ebb and flow. “This can reduce total costs while ensuring adequate coverage to the times needed.” For instance, you could buy a 30-year term life insurance policy to cover your spouse until your retirement and a 20-year term policy to cover your children until they graduate from college. Compare life insurance quotes to estimate your costs.
Fidelity Mutual Financial recommends parents of young children choose 30-year versus 20-year terms to give them plenty of time to build up assets. With a longer term policy, you’re less likely to get caught short and have to shop for coverage again when you’re older, and rates are higher.