How much life insurance do I really need?

Steve Merrell |

Q: My sister-in-law just recently got her license to sell life insurance and suddenly it seems that every problem in the world can be solved with a life insurance policy. She even says that my wife and I need to buy more insurance. I’m not against life insurance, but I already have $250,000 on me and $100,000 on my wife. How much insurance do I need anyway?

A: I know that some life insurance agents can seem a little over-zealous at times. It’s like that old saying that to a hammer, everything looks like a nail. However, I think your sister-in-law may have grounds for thinking you could use more life insurance. Unless you have significant other assets and no young children at home, $350,000 in death benefit between you and your wife sounds a little light.

A lot of people have too little life insurance. According to a survey funded by LIMRA (an organization formerly known as the Life Insurance Marketing and Research Association) shows that there are 30 million underinsured people in America. In fact, 24 percent of households earning $100,000 per year or more had no coverage at all.

The amount of life insurance that is right for you depends on several things, including what you are trying to accomplish with it. For example, a family’s breadwinner might buy life insurance to protect her family should she unexpectedly die. Understanding what you are trying to accomplish with life insurance often makes it easier to quantify how much life insurance you need. A good financial planner can help you work through this question. However, to illustrate how you could go about deciding how much life insurance you need, let’s look at a hypothetical example that focuses primarily on income replacement.

Let’s suppose you are 42 years old with a wife who works and three children ages 12, 10 and 8. You and your wife earn $90,000 and $60,000, respectively. With your combined incomes, you are able to cover your living expenses and save a little bit for the future, including a modest amount for college.

If you were to die unexpectedly, your wife would suddenly face a shortfall in household income of $90,000 per year. Of course, some expenses would be eliminated, too, but not the mortgage or her car payment or the day-to-day costs associated with feeding and clothing three kids. Those expenses will continue for years into the future and life insurance can help her cover those expense. In very simple terms, your $250,000 in life insurance would cover less than 3 years of her income shortfall. So, if 3 years seems light, how many years coverage do you need?

A simple rule of thumb is to buy enough death benefit to cover income shortfall until the youngest child is raised and out of the house. Since your youngest child in our example is 8 years old, this means your wife will need to replace your income for at least ten years and probably a few years longer, if your youngest child goes to college. Therefore, instead of $250,000, this rule of thumb says you need at least $900,000 in death benefit (the $90,000 per year shortfall times 10 years.)

We can refine our answer further. For example, to this point we have ignored the fact that insurance proceeds are usually paid out tax-free. If we take that into account, based on the assumed income level, you really need to replace only about $72,000 per year in lost income or $720,000 in total death benefit.

We can refine it still further by taking into account the amount your wife will earn as she invests the insurance proceeds. If she can earn 5 percent per year and inflation averages only 2 percent per year (meaning her investments earn a 3 percent real return), you will be able to get by with only $620,000 in total death benefit.

Of course, these numbers are based on a very rough rule of thumb, but they hopefully highlight an important point—take time to carefully think about how much insurance you really need. If I were in your shoes, I would get together with a good financial planner and crunch some numbers.


Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey.   He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to