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If you’re reading this, you’ve probably already decided that you are going to buy life insurance. Smart move: Life insurance will, in the case of your untimely death, protect your loved ones. If you keep up with your monthly premiums, your beneficiaries will receive a lump sum payment that will help them replace the money you would have otherwise earned. Expenses like your mortgage, a child’s education, monthly utilities and more need to be factored in.

Wondering how to do the math? Let us help you out with some simple methods for calculating that amount of coverage that will give you peace of mind.

How to Manually Calculate How Much Life Insurance You Need

Here’s a great way to get started: Take out a piece of paper or open a document on a computer and start making lists. In one list, you are going to look at all the financial obligations that lie ahead. In another, you’ll consider all the assets you have that could be used to fund these expenses for your loved ones if you were not around.

For the financial obligations ahead, make sure you come up with a figure that includes:

•   Your income over the term of the insurance policy.

•   Daily living expenses (food, utilities, medical care) if you don’t think the income in the line above would cover that sufficiently.

•   Your mortgage. If this is covered by your income, you don’t need to add this, but if not, you want to make sure your loved ones can pay this loan off over the years.

•   Any other debts. Do you have a chunk of credit card debt? Student loans? Those will need paying. Also think about end-of-life costs. Grim as it may be, you don’t want loved ones struggling to pay for funeral costs. These are not insignificant. In 2021, the cost of a funeral and burial was typically almost $8,000. In addition to that, there may be additional costs for gravestones, an obituary, and the like.

•   Tuition. Think about how many children you have or plan to have. The current annual cost for an in-state student at a public 4-year institution is $25,615; for a private university, that number rises to $53,949. Don’t forget to account for inflation, too.

•   Childcare if applicable. Think about whether your income alone would cover this, or if more funds would be needed to pay for these costs.

Add these costs up, and those are your life insurance needs. But now, let’s look at assets that might go towards paying these costs were you not alive. Include the following:

•   Savings. What do you have in savings (include your retirement accounts if you believe your loved ones would tap into those versus keeping them aside)? Also look at any investment accounts you may own.

•   Other insurance policies. You may already have some insurance. Just keep in mind if it is something you have via a group life insurance policy at work, it will probably end if and when you change jobs.

•   College funds. If you already have, say, a 529 account that will help pay for your children’s higher education, add that to the assets list.

To find out how much insurance you need, take the first number (your financial obligations to be covered) and subtract from it the assets you have (the second number). Ta-da: You now have a number that you’d like your life insurance policy to at least equal.

3 Ways to Quickly Estimate Your Life Insurance Needs

Not everyone wants to do the math above, we get it. Here are a few other ways that may be a better match for you when it comes to estimating how much life insurance you need.

1. The DIME Formula

The DIME formula — an acronym that stands for debts, income, mortgage, and education — is a time-tested way to determine the right amount of life insurance to buy. Here’s how it works:

Debts Add them up, including car loans, student loans, personal loans, credit card balances (even if it’s a cringe-worthy number you plan on whittling down, you’ve got to include it), 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. Multiply your income and the potential number of years you want covered by life insurance.

Mortgage If you’re a homeowner, what balance remains on your home loan? If you are considering buying a home, what size mortgage would you get?

Educational costs If you have or are planning to have kids, estimate how much tuition would cost for each and determine the total needed to fund higher education.

Add up these D, I, M, and E amounts, and that’s how much life insurance coverage you need. Worth noting: This technique doesn’t recognize any assets you might have, so it might tend to have you buy more life insurance than you need.

2. Use an Online Calculator

Sometimes it’s easier to use a digital tool that holds your hand through calculations like these. If you love clicking your way to answers, try a life insurance calculator to help streamline the process. Many are available online.

3. Try the Multiplication Trick

Some people like to use a formula to figure out how much life insurance they should get. Typically, this says to take your income, multiply it by a number (usually 10, but sometimes much lower or higher) and bingo! That’s the amount. Prevailing wisdom, though, is that this can be a very inaccurate figure. And it certainly doesn’t take into account the subtleties of your situation, whether that means you have to pay whopping student loans from grad school, alimony, caregiving expenses for a parent, or another expense. So while you may hear about this shortcut, it’s not considered reliable.

Who Needs Life Insurance?

Many people would benefit from life insurance, and most Americans do have a policy. Buying life insurance protects your dependents in the event of your dying; it provides a lump sum payment that can keep them financially afloat.

If, however, you are a person without dependents or any shared debt (such as being a co-signer with your parents for a student loan or with a partner on a mortgage), then you may not need to buy a policy. But for those who do have people depending on their earning power, life insurance can be a wise buy.

Many people get a policy when they are anticipating the major “adulting” milestones of marriage or parenthood. It’s likely to be particularly important if you are the primary earner in your marriage. If tragedy were to strike and you died, your spouse could be hard-pressed to maintain their standard of living and pay the bills. The rule of thumb is that the sooner you get insurance, the better. Rates go up as you age.

Next Step: Buying Life Insurance

Once you know how much life insurance you need, it’s almost time to start shopping. Almost. Let’s take a quick look at the two main types of life insurance, term life versus whole life insurance — and the 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

As the name suggests, this kind of policy lasts 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. This can work well for people who think that, at the end of the term, they’ll have saved enough money that they no longer need income replacement. Or, they may believe that beneficiaries will have gained financial independence by the time the policy ends.

Whole Life Insurance

This option offers coverage for your “whole life” as the name suggests, and is a popular choice among the different kinds of permanent, or lifelong, insurance policies. Payments are typically higher, perhaps as much as five to 15 times more than the same amount of coverage as a term life policy, but part of this whole life premium is a contribution to the policy’s cash value account. This savings vehicle can grow and may be borrowed against if needed.

Choosing Term or Whole Life Insurance

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.

That said, some people prefer the ongoing coverage of whole insurance and the peace of mind it can bring. Others may like watching their cash account grow. It’s a personal decision; only you can judge which kind of life insurance best suits your specific needs.

The Takeaway

Buying life insurance is an important step. It secures the financial future of your loved ones who rely on you and your income. Figuring out just how much life insurance you need is a necessary part of the process that can feel complicated. Fortunately, there are a number of different ways to get a solid estimate for that figure. The ideas we’ve shared not only help you do just that, they may also give you a deeper understanding of you and your family’s financial future.

Let SoFi Help Protect You

Once you have a rough idea of how much life insurance you’d like to buy, why not consider what 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 buying $3 million or less in coverage.

Interested in the fast, easy, and reliable route to life insurance? Check out what’s offered by SoFi in partnership with Ladder.

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Ladder Insurance Services, LLC (CA license # OK22568; AR license # 3000140372) distributes term life insurance products issued by multiple insurers- for further details see ladderlife.com. All insurance products are governed by the terms set forth in the applicable insurance policy. Each insurer has financial responsibility for its own products.
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 Ladder Life™ policies. SoFi is compensated by Ladder for each issued term life policy.
SoFi Agency and its affiliates do not guarantee the services of any insurance company.
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.

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The term “credit spread” refers to two separate financial terms.

A credit spread is an important indicator of investor sentiment that compares the yields offered by Treasuries and corporate bonds as a way of understanding how optimistic or risk-averse investors are feeling.

But credit spread also refers to an options-trading strategy where an investor sells a high-premium option and simultaneously purchases a low-premium option on the same underlying security.

Recommended: What Investors Should Know About Stock Spreads

Credit Spread – the Market Indicator

A credit spread is the gap between the interest rate offered to investors by a U.S. Treasury bond versus another debt security with the same maturity. The differences in the yield of the different bonds, or credit spread, typically reflects differences in credit quality between Treasuries and other bonds.

Investors will also sometimes call credit spreads “bond spreads” or “default spreads.” For investors, credit spreads give investors a quick shorthand for comparing a particular corporate bond versus its risk-free alternative.

When investors refer to credit spreads, they usually describe them in terms of basis points, each of which is a percent of a percent. For example, a 1% difference in yield between a Treasury bond and a debt security of the same duration would be called a credit spread of 100 basis points.

For example, if a 10-year Treasury note offers investors a yield of 3%, while a 10-year corporate bond offers to pay investors a 7% interest rate. There would be a 400 basis-point spread.

Recommended: What is Yield?

The bonds issued by the U.S. Treasury are the benchmark of choice because the financial-services industry considers them relatively risk-free, given their backing by the U.S. government. Investors consider corporate bonds, on the other hand, riskier, even when they’re issued by the largest, longest-tenured and most highly rated companies in the most stable industries.

To purchase debt securities with that added risk, investors look for compensation in the form of extra yield. That’s why investors sometimes look at a debt security’s credit spread as an indicator of the perceived riskiness of a company’s bonds or the creditworthiness of the company itself.

Because they have a lower risk of defaulting, higher quality bonds can offer lower interest rates – and lower credit spreads – to investors. Conversely, lower quality bonds have a greater risk default, and so they must offer higher rates – and higher credit spreads – to compensate investors for taking on that risk.

Recommended: Pros and Cons of High-Yield Bonds

Why Do Credit Spreads Fluctuate?

The credit spreads of the bonds issued by a given company may change over time for a number of reasons. They may change because of macroeconomic fluctuations such as inflation, or the degree of market enthusiasm for the company issuing the bond.

When the equity markets seem headed for a downturn, both institutional and retail investors often sell stocks and corporate bonds, and then reinvest in U.S. Treasuries. That pushes down the yields offered by U.S. Treasury bonds as investors flee to safety, while the yields paid by corporate bonds rise in order to entice skittish investors. The result is a general widening of credit spreads across the board.

That dynamic is one reason that investors look at average credit spreads as a window into the overall market sentiment, in which wider credit spreads indicate declining investor sentiment. Narrower credit spreads typically signify more bullish sentiment among investors. That’s because during a bull market the safety of Treasuries holds less appeal to investors, forcing the notes to offer higher rates. Meanwhile, that same confidence leads investors to see corporate debt as less risky, allowing companies to issue bonds with lower yields.

What Is a Credit Spread in Option Trading?

Sometimes, investors use the term “credit spread” to refer not just to the difference in yield offered by a Treasury bond and a similar security, but also as a specific options trading strategy. The strategy is also sometimes known as a “credit spread option” or a “credit risk option.”

In an option credit spread strategy, an investor buys and sells options on the same underlying security with the same expiration, but at different strike prices. The premiums the investor receives on the option they sell should be higher than the premiums they pay on the option they buy, which leads to a net return for the investor.

The strategy takes two forms:

Bull Put Spread

In the bull put spread, in which the investor buys and sells options in which they’ll make a maximum return if the value of the underlying security goes up.

A bull put spread is often also called a put credit spread. In it, an investor sells a put option and purchases a second put option with a lower strike price. For the strategy to work, the investor buys the same amount of both options and, both options will have the same expiration date.

In a bull put spread strategy, as long as the price of the underlying security remains above a certain level, the strategy will begin to produce profits as the differences between the value of the two options begins to evaporate as a result of time decay. Time decay is how much the value of an options contract declines as that contract grows closer to its expiration date.

As the name indicates, the bull put spread is a strategy used by investors who are bullish on a security. And the higher the underlying security rises during the options contract, the better the investor will do. But if the underlying security falls below the long-put strike price, then the investor can lose money on the strategy.

Bear Call Spread

The other credit-spread is called the bear call spread, or a call-credit spread. That strategy is, in many ways, the mirror opposite of the bull put spread. Investors in this strategy expect that a security’s price will go down. In it, the investor buys and sells two options on the same security, with the same expiration date but at prices where the investor will receive the maximum return if the price of the underlying security sinks.

A bull put spread can be a profitable strategy if the investor remains under a certain level over the duration of the options contracts. If the security is below the short call’s strike price at expiration, then the spread seller gets to keep the entire premium, giving the investor a healthy return. But the risk is that if the price of the security rises above the long-call strike price at the expiration of the strategy, then the investor faces a loss.

Recommended: A Guide to Options Trading

The Takeaway

A credit spread is an important indicator of investor sentiment. It’s also an options strategy where a high premium option is written and a low premium option is bought on the same security. Understanding the meaning of terms like credit spread is an important step for new investors who are just starting to invest in stocks.

The SoFi options trading platform is a great way to get started, thanks to its user-friendly design. Investors can trade from the mobile app or web platform. And should any questions come up along the way, there’s a library of educational resources about options available.

Trade options with low fees through SoFi.

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Photo credit: iStock/Astarot

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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