Do you need life insurance, how much do you need and when should take out a policy? These are all important questions. Unfortunately, there is no simple calculation or answer to this question as everyone is different and therefore has unique requirements.
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However, there are some important factors that can help you answer these questions realistically.
Do You Need Life Insurance
If you have any person (such as a spouse, parents or minor children) who are financially dependent on you, the answer is a definite yes. Your life insurance will cover their financial needs in the event that you are no longer able to provide for them. You can also consider taking out a policy simply to leave funds for a loved one after you are gone, even if they are not solely dependent on you.
How Much Life Insurance Do You Need?
This is a far more complicated question to answer. There are a variety of life insurance calculators that can provide an answer but these can provide different amounts and are in reality only an estimate. In most cases, an estimate is good enough.
Some of the rules of thumb that you may want to use when calculating the amount of cover you need include:
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1.1. Income Times Ten
This is a very simple calculation – take your gross annual income and multiply this by 10. Basically, this calculation is aimed at providing for your family for the next ten years based on your current income. However, it does not take into account inflation, interest, your debt, mortgage as well as future expenses such as education that need to be taken into account. This figure can often leave your family lacking just a few years after you are no longer there to support them.
1.2. The DIME Calculation
This calculation takes into consideration Debt, Income, Mortgage and Education (DIME). There are many variations on this calculation that may include additional factors such as how many years of coverage will be needed. The amounts attributed to each factor may also differ and is likely to change as time goes by.
- Debt is the total amount of debt that you currently owe including interest.
- Income is your annual net income multiplied by the number of years that your family may require financial support.
- A mortgage is an amount still owing on your mortgage, bond or home loan.
- Education is how much your children will need for a college education.
Private colleges can set you back around $35,000 a year. A three-year course can, therefore, cost $105,000. It is recommended to provide at least $100,000 per child for their future education requirements. More if you would like their student housing, books and other needs covered too.
This is probably the best calculation to bring you closer to the amount of life cover you may need. You may also want to add the estimated cost of your funeral to the calculation. But even this calculation has its shortfalls as it doesn’t take into account any assets, liquid or otherwise that you may have. It also doesn’t take into account any other provisions that you may have made for the future such as a trust fund for the kids or an education policy.
1.3. DIME Calculation Plus
Once you have completed the DIME calculation, it is a matter of calculating the value of your assets. These can include your savings, any investments that you may already have as well as fixed assets such as a house that is paid off. You may also want to deduct any existing education policies or trusts that you have in place for your children’s future from the education portion of the DIME calculation. This will give you the closest.
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When Should You Take Out Life Insurance?
It is never too early to take out a life insurance policy if you have anyone who is remotely dependent on you. It is recommended to reassess your needs every few years taking into consideration factors such as increased income, additional assets as well as the interest rate.
How much should you invest?
There is one more very important rule of thumb that needs to be taken into account and this is your budget. You should never invest more in a life insurance policy than you can afford even if this means that you opt for an amount of cover that is lower than what is estimated or recommended.
As a rule of thumb, it is recommended that no more than 6% of your gross income (before deductions) should be set aside for life insurance. However, this is, of course, dependent on how much you earn and free funds you have available at the end of the month. If you have a high amount of disposable income on hand, you may want to contribute slightly more to your life insurance policy.