Many employers offer life insurance as an employee benefit. If there’s little-or-no cost to you, there’s really no reason not to take the coverage. You’ll likely still want a separate policy you can control, however. The policies offered by employers 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. Typically, this isn’t enough coverage for most households. Additionally, if you leave your job or get caught up in a round of unexpected layoffs, your group term life insurance policy usually doesn’t follow you, which means your coverage can suddenly disappear. Take the benefit if it’s free, but consider buying your own policy as well to help protect your family.
For most new families, term life insurance is the most affordable coverage solution. Term life is intended to cover a fixed-length financial commitment and to provide income replacement if an income earner 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, like the 30-year term in the above example, 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 amount 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.