Do You Have the Right Life Insurance Coverage? Here’s How to Tell

Do You Have the Right Life Insurance Coverage? Here’s How to Tell

September 06, 2023

When families get together to explore life insurance possibilities, they frequently pose two fundamental questions: How much life insurance should I have, and what type of life insurance best suits my needs?

Similar to many other decisions families face, there’s no one-size-fits-all response. While some households may find permanent life insurance the right fit, others may discover greater value in cost-effective term coverage, offering a substantial death benefit.

Furthermore, the amount of coverage needed will vary depending on certain factors, such as career stage, income level, and the extent of your financial responsibilities and debts. So before you buy a life insurance policy, you’ll want to think about its costs and what you’ll get from it before making this important financial decision.

Assess Your Current Life Situation

As previously mentioned, the amount of life insurance coverage you need varies based on your current life situation, including your income level, expenses, debts, and the number of dependents relying on you. When you pass, your beneficiaries receive a payout, called a death benefit. The tradeoff for the benefit is the annual premium you pay on the policy. In general, life insurance is necessary if there will be a financial burden left by your passing, or if you would like to use it as an inheritance vehicle. For those with limited assets and debts and no dependents or heirs, life insurance is less important. 

Determine Your Coverage Level

Life insurance is meant to replace the earning potential lost when you pass away, which means the higher your income level, the higher insurance coverage you’ll need. Similarly, if you have higher expenses or large outstanding debts (like a mortgage), you’ll want to purchase at least enough insurance to cover these liabilities. 

Next, consider any dependents who may be relying on you. Do you have a spouse or children? Does your spouse work? How long will they need financial support in your absence? Do you plan to pay for your children’s college education? You may also want to think about what it would require to replace your surviving spouse’s income for a period of time in the event of your passing.

Let’s take a look at the most common rules of thumb for calculating your coverage level, keeping in mind that each person’s situation is unique and it’s always best to work with a financial professional before purchasing an insurance product.

10x Income Rule

This rule suggests you should have life insurance coverage equal to 10 times your annual income. For example, if your annual income is $75,000, you should have $750,000 in life insurance coverage. This rule of thumb jumps to 20 times your annual income if you have young children or a dependent spouse.

DIME Method

This rule suggests you should consider four factors when determining the appropriate amount of life insurance coverage: debt, income, mortgage, and education. Add up your debts (like credit cards, auto loans, and personal loans), multiply your annual income by the number of years you want to replace it, add the amount of your outstanding mortgage, and add the cost of your children’s education. This gives you a rough estimate of the amount of coverage needed.

Needs Analysis Method

This method involves a more comprehensive evaluation of your financial needs. It takes into account factors such as your current and future income, your debts, your children’s education, and your retirement savings. A financial advisor can help you with this analysis and determine the appropriate amount of coverage for your situation.

Understand the Types of Coverage Available

After you have a general sense of the coverage level you need, it’s important to understand the types of life insurance available. 

Term Life Insurance

Term life insurance, typically less expensive than other types of insurance, provides coverage for a specified period of time, usually 10, 20, or 30 years. If you pass away during the specified term, your beneficiaries receive a death benefit, but if you don’t die during the term, the policy expires and you’ll have lost the money spent on premiums.

Because term life insurance is one of the least expensive and simplest types available, it’s typically recommended for those who only want coverage for a specified period of time, such as until your kids reach a certain age or your mortgage is paid off.

Whole Life Insurance 

Whole life insurance is a form of permanent life insurance that has a guaranteed death benefit and coverage that applies as long as your premiums are paid. This type of insurance can have several different varieties—guaranteed, universal, variable, etc.—and varies depending on the individual’s needs.

Coverage will not decrease or be revoked, and premiums will not increase or decrease over the life of the policy. Coverage can increase based on increases in cash value or reinvestment of dividends, but it will never decrease below the guaranteed value. The growth of the cash value can be based on a fixed rate of interest or it can be variable. The cash value will grow on a tax-deferred basis, but once money is withdrawn from the policy, any earnings will be taxable as ordinary income.

Whole Life vs. Term Insurance

At Wilkinson Wealth Management, our philosophy centers on the value of having insurance while avoiding the pitfall of over-insurance. In our approach, we often favor term insurance for several reasons. First, it tends to be more budget-friendly, making it accessible to a broader range of individuals and families. Second, term insurance offers the flexibility to align the coverage term precisely with an individual’s needs, whether it’s the duration of a mortgage or their working years. This means you will be adequately protected during the critical phases of your life without carrying unnecessary financial burdens.

Work With a Trusted Advisor

If you find yourself uncertain about your life insurance coverage, you may want to think about collaborating with a financial advisor or an insurance expert who can help you determine the right policy tailored to your specific needs. Because every situation is different, we use various rules of thumb to help you evaluate your insurance needs and are able to discuss them on a case-by-case basis. Bear in mind as well that life insurance isn’t a one-time decision; periodic reviews can help keep it in alignment with your ever-evolving needs.

At Wilkinson Wealth Management, our mission is to guide pre-retirees, retirees, and young professionals in establishing a strong sense of stability regarding their long-term financial goals. If you have questions regarding your life insurance or wish to have a broader conversation about your overall financial situation, please don’t hesitate to reach out to us at 434-202-2521 or use our Contact Us page to schedule an appointment.

About Darren

Darren Kinsey is the Manager of Financial Planning Services for Wilkinson Wealth Management, LLC. He is the primary person for financial planning operations. He assists advisors in all aspects of completing financial plans, so if you are doing planning with us, you will likely interact with Darren.

Darren holds a degree in business from Longwood University, with a concentration in finance. Darren grew up outside of Richmond and moved to the Charlottesville area after graduating college. Outside of the office, he enjoys playing guitar and soccer, as well as spending time with his dog and wife.