Many employers offer free or low-cost life insurance as an employee benefit, so there’s no reason for you not to take the coverage. However, the coverage amount you are opting in to may not be enough.
Generally speaking, employer-provided life insurance policies are often annually renewable group term life policies. In most cases, the coverage amount is equal to a year (or two) of earnings – at most. While employer-provided coverage may be sufficient for some families, it won’t cover the needs of most households.
Additionally, group term life insurance policies are not portable in most cases, meaning your coverage will disappear if you leave your job at the company providing you that policy. Separate from the negative impact of losing the coverage you had, this is problematic because life insurance policies only go up in cost as you get older. So seeking an individual policy after you leave a job where you had minimal coverage means you’re likely to pay more for a monthly premium than you would have if you had taken out a policy when you were younger. Take the employee benefit if it’s free, but consider buying your own policy as well to protect your family long-term.
So what type of coverage do you need, and how long will you need it for? Term life insurance is the most affordable coverage solution, which provides coverage at a fixed monthly rate for a selected period of time. It’s intended to cover a fixed-length financial commitment - providing income replacement if an income earner dies early, or financial resources to cover household duties and childcare if a stay-at-home parent dies early.
Consider the time frames for mortgages and/or college for kids when choosing a coverage term. If your new family requires that you buy a new house, as often happens, you’ll probably want to get a term life policy that can cover your financial obligations for the length of the mortgage. Even if you expect you’ll be able to pay off the mortgage early, you might also need to consider the cost of raising a new family for 18 to 22 years – or until your youngest is out on their own. On occasion, a second or third child comes along years later, making a 30-year term an attractive length for families who initially anticipated paying off the mortgage early.
Once you establish a term length, you’ll need to choose a coverage amount. There are several rules of thumb for choosing an amount. One suggests that you multiply your income by 10 and purchase that amount of coverage. Another variation uses the 10 times income rule and then adds $100,000 per child. Rules of thumb can be handy, but they are also largely arbitrary. Instead, you may want to take a slightly more detailed approach.
To calculate your life insurance coverage needs in more detail, the DIME method considers Debt, Income, Mortgage, and Education.
Debt: Include auto loans, credit cards, student loans, etc. when you are determining the amount of your current debt.
Income: Multiply your current annual income by the number of years you’ll have dependents, usually about 18 years.
Mortgage: You’ll probably want the mortgage balance paid off so your family can maintain the house they call home.
Education: Your life insurance death benefit can provide for your children’s anticipated college expenses as well.
Add the numbers from above to get a starting figure. If you have significant savings, you can subtract the amount you already have saved, making it the DIME-S method instead.
Regardless of the method you use, you should now have a better understanding of the financial considerations many use to determine a term length and coverage amount that meets their term life insurance needs.