By Greg Hart, CFP®
When it comes to your overall financial picture, insurance planning is one piece that you do not want to overlook. One of the common questions that we often hear is, “How much life insurance do I need?” While the answer is going to be different for everyone, we hope to provide some context so that you can feel more confident in answering that question for yourself.
At a very basic level, life insurance can be categorized into two camps: Term Life Insurance and Cash Value Life Insurance (aka Whole Life or Universal Life). Term Life Insurance is insurance that covers you for a fixed period of time, such as 10, 20, or 30 years, but has no cash value. Cash Value Life Insurance covers you indefinitely (in most cases), includes an investment component, and should gradually build cash value in addition to the death benefit. It is important to note that Term Life Insurance is usually the cheaper option, but that doesn’t always mean it’s the best option. Depending on your life stage, needs, goals, and preferences, there are a few options that you should carefully consider for your insurance planning needs.
When determining how much insurance to purchase, it all comes down to your individual situation. What life stage are you currently in? Are you married? Do you have children? What liabilities do you have? When you have answers to those kinds of questions, you will have a better idea of how much coverage you will need and for how long.
A Few Rules Of Thumb
One rule of thumb is to have insurance coverage that is a specific multiple of your annual income. For example, you could have coverage that is 5, 7, or 10 times your annual salary. If you are considering this blanket rule, we would recommend considering your specific situation within this framework. For example, if you have a large amount of assets which would allow you to partially self-insure, you may only need 5 times your annual income. However, if you are on the other end of the spectrum and only have a small amount in assets, you might want to consider having 10 times your annual income in insurance coverage.
To make this rule of thumb even more specific to your situation, you should also take into consideration your liabilities and expenses, such as mortgage, other household debt, college costs for children, funeral costs, etc. You could add these total costs up and include them with the annual salary multiple that you choose. But there’s much more to consider.
When you start thinking about tailoring your insurance planning needs to your specific situation, you may also want to consider multiple policies that are pegged to different goals. As an example, if you own a home with a mortgage, you can cover yourself by buying a term insurance policy for the amount owed on the home and for the length of time remaining on the mortgage. Another example of this could be taking out a 10, 20 or 25-year term insurance policy for the cost of college for each of your children. To make sure that you do not leave the financial burden of a mortgage or paying for college on your spouse, you can instead plan appropriately in advance by tying these policies to specific, predictable goals.
It is important to note that your insurance needs will change as you transition through different life stages. When you are single and have no dependents, life insurance may not make sense to have at all. However, once you get married and have children, insurance planning becomes more important. Add to that the complexity of owning your own business, different levels of household assets and liabilities accumulated, estate planning, etc., and you will quickly realize that there is no one-size-fits-all approach. Finally, as you get into retirement, insurance needs will change again.
Proper Planning Is The Way
When looking at a successful comprehensive financial plan, the reality is that all of the moving pieces are meant to work together. From investment allocation to insurance planning to retirement and estate planning (to name a few), the amount of insurance needed will differ from person to person depending on how all of the pieces fall into place. While the purpose of the above advice is to provide a general overview of how much insurance you may need, the best answer will always come from a 360-degree view into your overall financial life. We at Haddon Wealth Management create comprehensive financial plans for our clients which includes a thorough insurance analysis for your unique situation. While we don’t sell insurance, nor are we compensated for it, we will be with you every step of the way to guide you through the process. We can work with your insurance agent or help you to select a brokerage firm. To start a conversation, call us at (856) 888-1744 or contact us online to schedule a complimentary get-acquainted meeting.
Gregory M. Hart, CFP® is the founder and managing director of Haddon Wealth Management, LLC, a registered investment advisory firm that provides comprehensive wealth management (in-depth financial planning and sophisticated investment management) for clients who value a relationship-driven approach that delivers customized solutions. Based in Haddonfield, New Jersey, Greg works with clients throughout the Delaware Valley, as well as nationwide. To learn more, connect with Greg on LinkedIn, visit our website at www.haddonwealthmgt.com, or call (856) 888-1744 to begin a discussion.