Rule of Thumb: How Much Life Insurance Do I Need?

Use Your Annual Income To Determine How Much Coverage To Carry

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The “10 times earnings” rule of thumb helps you determine how much life insurance coverage might be appropriate for your family. If you use this approach, you would purchase a life insurance policy with a death benefit equal to 10 times your annual income. Some people propose higher or lower amounts, and a rule of thumb is never the perfect way to determine how much life insurance you need, but it can still help you gauge a rough coverage amount or give you a place to start.

In this article, we’ll explore the pros and cons of this rule, how to use it, and consider alternatives to this simplified approach.

Key Takeaways

  • A “quick and dirty” way to gauge how much life insurance coverage you need is to multiply your annual income by 10 (or add a zero to your annual income).
  • Other methods calculate your coverage needs by analyzing your expenses and anticipating changes in your finances.
  • Rules of thumb can oversimplify complex topics, and it’s best to do a thorough review of your needs before making important decisions like how much life insurance to buy.

What Is the Rule of Thumb for How Much Life Insurance I Need?

A popular rule of thumb for life insurance says that you should have one or more life insurance policies with a total death benefit equal to roughly 10 times your annual salary (before taxes and other paycheck deductions). The death benefit is the amount your beneficiaries receive when the policy pays out, so this is the amount they can use to support themselves after you die.

Like all rules of thumb, this is a simplified strategy. It does not consider your finances (other than your income), existing assets, or your beneficiaries’ needs in detail. While this approach can alert you if you’re significantly underinsured, it’s probably not the ideal way to buy life insurance. In a perfect world, you’ll complete a more thorough review of your needs to arrive at an appropriate number.

But when you’re looking for a quick estimate, the 10-times-earnings rule can be a decent starting place.

If you have children, you could adjust this rule by adding $100,000 or more for each child’s education expenses.

Where Does the Rule of Thumb for Life Insurance Coverage Come From? 

The income-based rule of thumb is a popular way to simplify decisions about how much life insurance you need because the calculation is easier and faster than more complex methods, such as ones that incorporate all your income and assets, debts, and future earnings. Plus, when life insurance agents complete an analysis for clients, they arrive at a proposed death benefit designed to satisfy basic needs, and that amount tends to come in at around 10 times your salary, according to Paul Moyer, a life insurance agent and financial educator in South Carolina.

While it’s not entirely clear where this specific rule of thumb originated, the process of determining how much coverage you need based on your income has been around for years.

The Income Rule vs. the DIME Formula and Other Alternatives

Other rules of thumb that take a different approach than the income rule may be preferable when buying life insurance.

DIME: Debt, Income, Mortgage, Education

One popular life insurance rule is the DIME formula, which focuses on four things:

  • Debts: Add up all loan balances except mortgages.
  • Income: Multiply your annual income by the number of years you think your dependents will need support. For example, it could be until your youngest child graduates from college. If no one depends on your income, you might skip this step.
  • Mortgage: Determine how much you owe on your home, including any second mortgages or lines of credit against it.
  • Education: Estimate the cost of paying for education for any children you have.

Combine the expenses above, and you have a rough estimate of how much coverage you might need to buy. You could reduce that number if you already own one or more insurance policies, or increase it to account for anticipated raises throughout your career.

The DIME formula focuses on specific spending categories instead of your current income. As a result, it may be more likely to cover your family’s essential needs. However, your beneficiaries could still come up short if they will have expenses that don’t fall into those four categories.

You can modify the DIME method to include additional expenses, such as medical expenses or retirement funding.

Other Approaches

Several other methods can help you decide how much life insurance you need, some of which can be very complex. For example, the Human Life Value approach uses more complicated calculations to estimate the present economic value of your future earnings over a certain number of years. You could also determine the number of years in which you’d like to provide an income or income supplement to your survivors, as well as an annual amount to provide them. Then you can use a financial calculator to determine a death benefit that could provide that amount based on a conservative rate of interest.

The 10-times-income rule is probably the easiest to calculate, but that simplicity may result in less accuracy.

Grain of Salt

Rules of thumb might give you a rough idea of an appropriate coverage amount. But with something as important as life insurance, it’s critical to do a thorough review of your family’s needs. Here’s how the income rule of thumb can fall short:

  • It ignores people who don’t earn income, perhaps because they’re caring for children. With zero income, you might assume you need little or no insurance. But replacing a stay-at-home parent’s time and energy can be costly. A study done in 2018 indicates that a stay at home parent's value is approximately $162,581.
  • If your income is currently low but poised to rise, you might buy a policy that’s too small.
  • If you have high levels of debt relative to your income, you might not get enough insurance with the 10x rule to cover those debts.
  • Family members with special needs might require additional funds to access proper care.
  • The rule ignores assets you already have. If you’re financially independent, you might not need additional life insurance.

How Do I Calculate How Much Life Insurance I Need?

If you choose to use a rule of thumb based on your income, multiply your gross income (before taxes and other payroll deductions) by your multiplier. For example, if you want 10 times your salary and you earn $70,000 per year, you would multiply $70,000 by 10 to get $700,000 (or just add a 0 to your annual income). You can apply this to each wage earner in your household—for example, two parents each earning $70,000 per year would each purchase $700,000 worth of coverage using this rule of thumb.

There’s no way to predict the future, but attempting to find the right amount of death benefit is crucial. If you’re underinsured, your loved ones may suffer financially after your death. But if you’re overinsured (which is rarely, if ever, the case when a policy pays out), you’ll spend more on premiums than is necessary.