How much life insurance should you have?
It's not a strict formula
There are a million articles and rules of thumb for how much life insurance you “should” have. “Should” is in quotes because life insurance is fundamentally an altruistic act. It's something you do for the people you leave behind because you feel a sense of obligation, duty, or generosity. It is, in short, a mix of financial elements and psychology (welcome to everything in finance!). So rather than a strict equation to determine how much to get, here is a list of categories to consider building into your total death benefit. For any category you want to include you decide how much money you want to cover it. At the end, you add up all the categories to get a final total that represents your specific desires for what you want to provide if you die unexpectedly.
1) Final Expenses and Wrap Up Costs
When we pass away there are usually various expenses that need to be paid. Bills that come up specifically because someone has died. Some are obvious, such as funeral costs, but some are less obvious. For example, attorney costs, accounting fees, medical and hospital expenses and the like. It adds up, more than you might expect.
Early in my career a friend of mine died in a freak accident at home and didn't have any life insurance. His family was forced to crowdfund these final expenses and had to raise the goal from the initial ten thousand up to twenty thousand dollars as the bills rolled in. Nothing lavish, he and his family never had much money, just the costs of dying and some measure of dignity in laying him to rest.
This category can encompass a number of potential situations. You may be married and want to provide money to pay off the mortgage to your house. Or pay for the apartment rent for a number of years. Maybe you want to make sure your family has the money for a down payment for their forever home. Whatever the specific situation, the goal here is to help those you leave behind have a safe and secure place to live.
All too often we might pass away and have debts that could burden those we leave behind. Aside from the mortgage, usually covered in the Housing category, there might be car loans, credit card debt, a partner's student loans, and more. Especially if you are married or otherwise have assets you want to make sure stay intact for your heirs (such as a house or bank accounts), you may want to consider increasing the death benefit OR increasing the life insurance proceeds to retire debt so that creditors won't come after your estate. Or in the case of debt held by your partner, just to make things easier for them.
4) Emergency Fund
Ideally, every couple would have an emergency fund set aside in case of job loss or sudden roof repair or the like. However, in reality, that's not always as easily done. Thus, many people include extra coverage into their life insurance just for their surviving partner to put into an emergency fund in case that roof falls in someday. The appropriate size of an emergency fund can vary, but a fairly common guideline is three to six months' worth of expenses.
Especially if you have younger children, money to provide for childcare expenses created by someone passing away can be a critical issue. Maybe one parent was the primary caretaker and now the survivor needs to pay for daycare for a toddler. Perhaps the child is a little older and it's more a question of an afterschool program or a babysitter. To figure out how much you might want to include in your coverage for this category, look at the costs of childcare for a year and then determine how many years you need to provide it. Then simply multiply the two.
Many parents want to provide some sort of assistance for post-high school education for their kids and therefore add some coverage to their policies to make sure that dying doesn't prevent it. If you've seen the movie “Good Will Hunting” (In my opinion, great movie!), the character of Skylar played by Minnie Driver is able to afford to attend Harvard University because her father died when she was thirteen and left her enough money. This is that. Whether it's college or vocational training or another kind of education, this can often be one of the biggest ways for a parent to give their children a leg up in their lives. Pick the amount you want to provide per year and for how many years and multiply them. You can search online for average costs of different kinds of schools and use those as a starting point.
7) Lifestyle Maintenance
When people read “lifestyle” I suspect many of them automatically imagine rich people living it up. But really, your lifestyle is literally just the way you live your life and spend your time and money, to whatever degree you're at. This category is providing for your family the ability to maintain their standard of living after you are gone. Having provided for housing and other expenses, things will already be easier for them, but you may want to make sure your spouse can still fund retirement savings and go out to dinner occasionally and your kids can go see a movie sometimes and continue their piano lessons. That sort of thing. Pick an amount per year that would help your family keep their lifestyle and then a number of years to provide it, then multiply.
If there is a charity that you are devoted to, that means something to you, designating money for them in your life insurance can be a way to make a significant impact. This category has less of an easy formula for how to decide on an amount. You can pick a round number that feels meaningful or potentially back into it based on how much different amounts affect your premiums once everything else more vital to your family has been taken into account.
Ultimately, there's no such thing as a truly complete list of categories people might build into their life insurance coverage, but these are some of the most common. Notably, very few people actually use every category; instead they pick and choose the elements that matter most to them and their families. At the end of the day you ask yourself, “Does this coverage provide what you want to have happen if you unexpectedly passed away?” If so, you've likely found the right amount of coverage for you.