The short answer could be to buy enough coverage to help address outstanding debts, while also providing enough money to beneficiaries for their financial needs. The real question, then, may be how to calculate that dollar amount.
At a high level, it can make sense to consider what’s owed on a home and other debts, what kind of money would be needed to pay college tuition for children, and projected expenses of significance. Make a list and add up the dollar amounts for a rough estimate of life insurance needs. This can be used as a starter figure.
The DIME Formula
The DIME formula—which stands for debts, income, mortgage, and education—is a detailed and time-tested way for someone to delve more deeply into their finances to help determine the right amount of life insurance to buy.
Debts. It can help to gather information about debts, including car loans, student loans, personal loans, credit card balances, and so forth. Include everything except mortgage payments (because that’s the “M” portion of this formula) and add them up. What’s the total?
Income. The goal of having a life insurance policy is to replace income that was coming in but would stop because of the death of the policy holder. One recommendation is to multiply annual income by ten (or more if it seems that beneficiaries may need to make the life insurance payout last more than ten years). So, if income is $75,000 per year and ten years seems like a reasonable timeframe to use in calculations, then that suggests the need for a policy of $750,000.
Mortgage. A home loan is typically the biggest debt that a person carries, often one that’s also the debt with the longest term.
A key priority of the financial planning associated with life insurance is facilitating the paying of or payoff of the home mortgage. Otherwise, survivors may be burdened with a debt and monthly payments beyond their ability to manage. This can be especially true if only one person in the household earns an income or earns the majority of it.
Although this isn’t pleasant to think about, if a key earner in a household dies when there is mortgage debt—and the payments can’t be met—then the family may be forced to sell the house or face the possibility of the home being foreclosed upon. So, how much money would be needed to pay off the mortgage? Adding that figure to the life insurance policy amount may be a wise decision.
Education. If children in the family plan to attend college, projecting tuition costs could mean they will still have the funds to make that happen. According to U.S. News & World Report , tuition for a private college for the 2020-2021 school year is averaging $35,087.
A public, out-of-state university averages $21,184 in tuition costs, while an in-state public university averages $9,687. That can at least serve as a guideline for annual tuition costs, but note that it doesn’t include housing, food, books, and other education-related expenses. How much would be needed for each child to earn a bachelor’s degree?
The type of degree pursued and the number of years it takes to achieve it also plays a role in the tuition’s cost, so this may be a starting point rather than a definitive piece of information.
Funeral costs, although not directly included in the DIME formula, are also something that can be considered in life insurance calculations.
People who have prepaid their funeral costs or have already purchased a cemetery plot may be able to skip over this step, but other people may want to ensure that their loved ones won’t need to worry about funeral expenses at an emotionally tough time.
A detailed breakdown from the National Funeral Directors Association lists a general price list, as well as information about how funeral costs range in a variety of regions of the United States. Two key figures include:
• The national median cost of an adult funeral with viewing and burial is $9,135, which does NOT include:
◦ Cemetery costs
◦ Monument or marker costs
◦ Any other cash-advance charges
• The national median cost of an adult funeral with viewing and cremation is $6,645, which does NOT include:
◦ Cremation casket or container
◦ Monument marker costs
◦ Any other cash-advance charges
Armed with all of this knowledge from the DIME formula with funeral costs added on, a person can create an estimate of what’s needed and get life insurance quotes based on these estimates. A life insurance calculator can help streamline the process.
When asking the question of “How much life insurance do I need?”, there’s another factor to consider: term life versus whole life insurance.
Term Life Insurance Versus Whole Life Insurance
These are the two broad types of life insurance options available—and there are key differences between them.
Although they share the same goal of protecting families financially when a tragic loss occurs, the elements of the policies, how much they cost, their terms, and more can be quite different.
Term Life Insurance
This is the more straightforward option. Someone takes out a term insurance policy and, as the name applies, it’s good for a certain period of time, or term. The policy is taken out for a designated dollar amount, usually with fixed premium payments—and, if the policy holder dies during that time frame, then designated beneficiaries can receive the payout they’re due. A policy can list one beneficiary or multiple ones.
Consumers who choose this type of life insurance might do so because they believe that, at the end of the policy’s term, they’ll have saved up enough money so they’ll no longer need income replacement. Or, they may believe that beneficiaries listed in the policy will have gained financial independence by the time the policy ends.
Whole Life Insurance
People who choose this option make regular premium payments on a policy that can be available for their entire life.
In other words, there is no predetermined term. Payments are typically higher, perhaps as much as three to ten times higher for the same amount of coverage as a term life policy, but part of this whole life premium is considered a contribution to the policy’s cash value.
The cash value portion of the policy can be borrowed against at an interest rate listed in the policy. If this policy is surrendered to the insurance company before the policy holder dies, and the cash value funds have not been borrowed, then that policy holder may be able to cash it out and receive the appropriate amount of funds.
Choosing Term Life or Whole Life
If affordability is especially important, then term life insurance can make more sense. Term life may also be the right choice if coverage is only needed for a certain period of time, perhaps while money is still owed on a mortgage or young adult children are in college.
Another reason why some people may choose term insurance is because they take the difference between that premium and what they’d pay for a whole life premium, and then invest those dollars in another way.
If someone wants to have their life insurance policy help beneficiaries pay inheritance taxes, then a whole life policy may make more sense. If that’s the case, consulting a tax professional for details would be a good step in the process.
People may also pick whole life if they have a family member with special needs who will need lifelong care. An attorney can help with setting up the appropriate trust.
Buying Sooner Rather Than Later
Buying a life insurance policy at a younger age may translate into a better value for the policy holder. That’s because people who are young and healthy typically get a better price for their policy; in general, they will be considered a lower risk by the insurance company. Plus, sometimes, when buying term insurance, the initial price will be locked in, meaning no payment increases.
SoFi is offering affordable term life insurance in partnership with Ladder. Applicants can receive a quote in just a few minutes for policies that range from $100,000 to $8 million. It’s quick and easy to set up a policy, and the coverage amount and associated premiums can be adjusted at any time with just a couple of clicks. No hassles.
Rates are competitive with Ladder and, because the agents do not work on commission, there are no fees. Plus there are no medical exams required for qualifying applicants and Ladder’s term insurance policies come with monthly payments that aim to never increase throughout the term.
Ladder offers term policies in New York (policy form # MN-26) that are issued by Allianz Life Insurance Company of New York, New York. Term policies are issued in all other states and DC by Fidelity Security Life Insurance Company®, Kansas City, MO (policy form No. ICC17-M-1069, M-1069 and Policy No. TL-146). Coverage and pricing is subject to eligibility and underwriting criteria. SoFi Agency and its affiliates do not guarantee the services of any insurance company. The California license number for SoFi Agency is 0L13077 and for Ladder is OK22568. Ladder, SoFi and SoFi Agency are separate, independent entities and are not responsible for the financial condition, business, or legal obligations of the other. Social Finance, Inc. (SoFi) and Social Finance Life Insurance Agency, LLC (SoFi Agency) do not issue, underwrite insurance or pay claims under LadderLifeTM policies. SoFi is compensated by Ladder for each issued term life policy. SoFi offers customers the opportunity to reach Ladder Insurance Services, LLC to obtain information about estate planning documents such as wills. Social Finance, Inc. (“SoFi”) will be paid a marketing fee by Ladder when customers make a purchase through this link. All services from Ladder Insurance Services, LLC are their own. Once you reach Ladder, SoFi is not involved and has no control over the products or services involved. The Ladder service is limited to documents and does not provide legal advice. Individual circumstances are unique and using documents provided is not a substitute for obtaining legal advice.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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