You can’t pinpoint the ideal amount of life insurance you should buy down to the penny. But you can make a sound estimate if you consider your current financial situation and imagine what your loved ones will need in the coming years. In general, you should find your ideal life insurance policy amount by calculating your long-term financial obligations and then subtracting your assets. The remainder is the gap that life insurance will have to fill. But it can be difficult to know what to include in your calculations, so there are several widely circulated rules of thumb meant to help you decide the right coverage amount. Here are a few of them.
- Rule of thumb No. 1: Multiply your income by 10.
- Rule of thumb No. 2: Buy 10 times your income, plus $100,000 per child for college expenses
- Rule of thumb No. 3: The DIME formula
This formula encourages you to take a more detailed look at your finances than the other two. DIME stands for debt, income, mortgage and education, four areas that you should consider when calculating your life insurance needs.
Debt and final expenses: Add up your debts, other than your mortgage, plus an estimate of your funeral expenses.
Income: Decide for how many years your family would need support, and multiply your annual income by that number. The multiplier might be the number of years before your youngest child graduates from high school. Use this calculator to compute your income replacement needs:
Mortgage: Calculate the amount you need to pay off your mortgage.
Education: Estimate the cost of sending your kids to college.
The formula is more comprehensive, but it doesn’t account for the life insurance coverage and savings you already have, and it doesn’t consider the unpaid contributions a stay-at-home parent makes.