Term Life Insurance: How Much Do I Need?

For the purposes of this article, I am only going to focus on how to help you find the right “face value” and “term” of your insurance policy.  If you would like more detail on why you might need term life insurance, please read my post “Should I Have Term Life Insurance?”.

Lets make up a little story to help us figure out how much life term life insurance is right for you and your family…

John and Kate are married.  Both are 30 years old and both make $100,000 a year pre-tax. They just had their first child (Junior), which has made them think about purchasing life insurance.

Before we get to the dollar amount question, lets answer another question: how long do we need to replace John’s income?  Ten years?  Thirty years?  Remember that the point of life insurance is to “fill in” for the income of the deceased spouse.  The thinking here goes like this: once Junior graduates college he should be able to support himself by getting a job and moving out of the home.  Therefore, 20 years of term insurance should be good enough to replace John’s income until Junior graduates college.  So 20 years is great starting point for the “term” of the policy.

Now that we know the “term” (20 years), we can now figure out the face value of the policy.  If John makes $100k a year, we multiply $100k by 20 years and get a face value of 2 million dollars.  But remember that John’s salary is pre-tax and life insurance payouts are in after-tax dollars, so we can adjust for taxes to lower the face value.  Lets assume John’s “take home” pay is $70k a year.  $70k a year multiplied by 20 years comes out to $1,400,000.  This $1.4MM number is a great middle ground.  $2MM of 20 year term insurance is a little “over insured”, but perfectly reasonable if you can afford the premiums.  I would ballpark $1MM of coverage as a little “under-insured” but still good – being under-insured is better than having no insurance at all!

Since Kate also makes $100k a year her policy will be the same.  As a couple, John and Kate should have about $2.8MM of 20 year term life insurance combined ($2MM low end, $4MM high end).  If John and Kate would like to be a little “over-insured”, they can raise the face amount or move the “term” out to 30 years instead of just 20.  Remember that any increase in face value or term will increase the annual premium due as well.

Lets change the situation around a bit by making Kate a stay-at-home mom.  Does she still need life insurance with no salary?  I think so.  John would need to hire a nanny or send the kids to daycare while he is at work – it makes sense to have some life insurance on a stay-at-home spouse.  Lets ballpark a very qualified nanny at $50,000 a year.  $50,000 a year for 20 years is $1MM.  So a $1MM policy with a 20 year term is a great starting point for insuring a stay-at-home spouse.

This exercise should help you get to a ballpark term life insurance dollar amount.  Each person or couple can have their own variables in the equation.  Maybe you have more than one child, or maybe one spouse in un-insurable.  If you would like me to help you with your specific insurance plan, let me know.  I would be happy to help!

Charles Brown is a Portfolio manager and Financial Advisor at M.Brown and Associates in Naperville, Illinois.