How Much Life Insurance Do You Really Need?

Bruce Hanks |

For most people the difficult decision is not “if” they need life insurance, but “how much” life coverage they need. It’s a much bigger decision, and one that can lead to consternation over the purchase decision if it is not made with the proper consideration.  Buying too much life insurance has always been a concern for people who don’t like paying for what they don’t need, and buying too little insurance can lead to a lot of sleepless nights and disaster for the surviving family. 

At its simplest, knowing how much life coverage you need should be based on precisely what the “needs” are.  Needs can and should be quantified so that the amount of life coverage can be determined with relative accuracy. Only then can you be assured that you own the right amount of coverage.

Clarifying Your Need

For a family, the list of needs may not be extensive, but they should be very clearly defined.

  • Debts – including mortgages, credit cards, personal loans
  • College expenses – determine cost of college education and how much to be funded
  • Final expenses – including final medical costs, funeral expenses, legal fees
  • Income replacement – determine surviving spouses earning capacity and the amount of income needed during and after dependency years.

Quantifying Your Need

Once the needs are clearly defined, they need to be priced, meaning their current costs need to be determined.  This is easy to do for lump sum requirements such as debt payoff. Even for future costs such as college expenses, it’s easy if you use today’s costs and then apply an inflation factor. But, the most practical way to measure any cost is to assume that death occurs immediately. As long as you apply a reasonable capital growth assumption for the proceeds that are invested to cover future costs, it should be sufficient when planning in today’s terms.

Calculating income needs is a little more complicated.  The income needed while the children are dependent will obviously include child-rearing expenses including clothing, food, recreation, education, medical, child-care and miscellaneous outlays. The non-dependency years of your spouse will require less income, but should be sufficient to allow for a continuity of lifestyle.  Again, the time horizon for the need is important, and if your spouse is not a primary bread-winner, it is never safe to assume that your income will be replaced by his or her own earnings which may not materialize in the manner or time frame you might hope for.

For each stream of income – one for the dependency years, and one for the non-dependency years, the calculation is made by totaling the income required for each period and then discounting it to a present value using a conservative interest factor. This will generate the amount of money needed today to produce the required income based on it earning an assumed rate of return.  The more conservative you are with your assumptions, the greater the cushion that can be created for added security.

Hypothetical Capital Needs Analysis -Husband (38) and wife (35) with two kids (2 and 4)

Lump Sum Cash Need:



College Funding (present value invested at 5%*)

$  50,000

Final Expenses

$  30,000

Total Lump Sum Cash Need


Income Replacement Need:

Current Family Income


Income lost at death of primary breadwinner


Income replacement during child dependency years (15 years) assuming debt and college expenses paid off


$2 million

Income replacement during non-dependency years until retirement (20 years)


$ 3 million

Present value of the two income streams invested at 5%*

$1.2 million

Total Capital Need (Lump sum cash needs + Income replacement)

$1.38 million


*5% is a hypothetical return and is not guaranteed

With your needs clarified, quantified, and their costs determined, you can then apply your existing resources as offsets to determine what is left uncovered.  For instance, if you have existing life insurance, savings, or investments, these assets are available to offset the need for additional life coverage.  If you have additional income sources, such as your spouse’s current income, income from a trust or rental property, it can be used to offset the income need. 

Capital Available


$  50,000

401k Plan


Group life insurance



Total Capital Available at death


Total Life Insurance Need

Total Capital Need less Total Available Capital

$1.2 million

Following this process you will be able to arrive at a coverage amount that provides you with the assurances that you have bought the right amount and that your family will be secure.  The process described here can be carried out on a few sheets of graph paper, or with the use of any number of financial calculation tools that are available for free on the internet. Better yet, have your financial advisor perform a life insurance needs analysis in the context of your overall financial plan.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2021 Advisor Websites.