How much term do you REALLY need?

Most people need just enough insurance to cover final expenses and to replace income that loved ones are dependent on. A useful rule of thumb that works on average for most people with stable incomes is to take your current annual income (actually, your after tax income plus all tax deferred contributions to health plans, pension or 401k plans, etc) and multiply it by the number of years until retirement, but no more than 20.

[For math buffs, the reason this rule of thumb works so well is that the average income growth rate is very close to the average rate of return on safe investments (with both income and investment return adjusted for taxes and inflation). If you partition the life insurance proceeds into equal annual portions from now until retirement, each portion will grow to match the higher wages. If this equivalence assumptions is not applicable, then a rather more complex calculation is required. To calculate the "exact" amount of insurance needed for income replacement, you need to know the year by year numbers for income and investment return (adjusted for taxes and inflation).]

Since few people can predict with any certainty income growth rates and future investment returns, the rule of thumb is likely to be as good as a more complex calculation for most people with stable incomes.

There are a number of reasons for having more or less life insurance protection than our simple rule of thumb. If your retirement income does not continue for your spouse upon your death, you would clearly need more insurance. If you are a single parent, the ages of your children and their plans for college will determine the amount of insurance you need (not your projected retirement age). If you have children with special needs, they may be dependent on you long after age 18. If you wish to endow a charity or have estate tax liability, you would want additional life insurance.

[To maximize commissions, many agents unfortunately will overstate the amount of life insurance that you need (by redundantly replacing both income and mortgage payments, for example; or by ignoring the tax free treatment of life insurance proceeds, which is needed to replace after tax income).]

InsuranceGuide is committed to helping you determine the amount that you need for your particular financial situation, just as we are committed to finding the right company for your particular risk profile.