A good “rule of thumb” is to obtain a life insurance policy that has a death benefit of at least 10 times your annual income. So, if you make $50,000 a year, you would want a $500,000 death benefit. In most cases, that is enough to help your family pay off any debts left behind and/or temporarily supplement the income you provided for the household.
A preferable way of determining the death benefit amount is to use a needs-based approach. This considers your total debt, annual income that your family would need, future social security benefits, current savings, and the investment returns that your money could make after you pass away.
If you have kids, this approach will also consider future college expenses.
PRO TIP – You do not need to include federal student loans in this equation. If you have federal student loans in your name, the debt is canceled in the event of your death. Private student loans can be tricky and are dependent on whether the lender offers a death discharge (also check to see if someone co-signed the loan with you).
Choosing the proper term
The term means how long the life insurance policy will cover you (as well as how long you will pay the premiums to be insured). A 20-year term would mean you make payments on your policy for 20 years. Additionally, a 20-year term policy would pay a death benefit if you died within that 20-year period.
The goal is to choose a term that covers you until you have enough assets where you no longer need life insurance. If you work with your financial advisor to make a plan where you are building wealth and you project that in 18 years you will have sufficient assets (and little-or-no debt!) that your family would be taken care of if you passed away, then a 20-year term insurance policy would be adequate!
PRO TIP – Choosing a term that is longer than your projected need is a good idea. Here is why – you can stop paying whenever you want without penalty! So, if your wealth quickly grows and you no longer need the insurance, simply stop paying! Once payment is stopped the life insurance company will cancel your policy and coverage will end.
Taking a little extra time to calculate how much insurance you need is paramount to protecting your family. The amount of wealth you build now is meaningless if you don’t properly provide for them through life insurance.
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