How to Calculate How Much Life Insurance You Need
A five-step guide to calculating your life insurance needs by adding up debt, income replacement, mortgage, and education costs minus existing assets.
Step 1 - Add Up What Your Family Would Need
Start by thinking about what your family would need financially if you died today. This is not a comfortable exercise, but it is the only honest way to choose a coverage amount. Consider two categories: one-time needs and ongoing needs.
One-time needs include final expenses such as funeral and burial costs, which average $8,000 to $12,000. Include any debts that would not disappear with your death — credit cards, car loans, personal loans, and any debts you co-signed. These creditors can still pursue payment from your estate.
Ongoing needs are the most important. Your family needs to maintain their standard of living without your income. Children need care and education. A surviving spouse may need time to re-enter the workforce or increase work hours. Estimate how many years your income would need to be replaced and how much per year.
Step 2 - Calculate Income Replacement
The income replacement portion of your coverage is usually the largest component. The standard approach is to multiply your annual income by the number of years your family would need support. Financial planners commonly use 10 to 20 years as the replacement period.
If you earn $70,000 per year and want to replace 15 years of income, the income replacement component is $1,050,000. This is not meant to be invested and withdrawn at once — the idea is that a surviving spouse could invest the lump sum conservatively and draw from it for many years.
Consider whether your spouse or partner earns income that would continue. If your partner earns $50,000 per year, your coverage does not need to replace the full household income — just your portion, adjusted for any changes in household expenses or childcare costs that would follow your death.
Step 3 - Add Outstanding Debts
Add your current mortgage balance. This is typically the largest debt and one most families want fully covered so the surviving spouse and children are not forced to sell the home.
Add all other outstanding debts: auto loans, credit cards, student loans, and any personal loans. Check your most recent statements for current balances. Use the actual payoff balance, not the original loan amount.
Total the mortgage balance and all other debts. This becomes the debt component of your insurance calculation. Some financial planners skip double-counting by only adding the mortgage separately and wrapping other debts into the income replacement calculation. Either approach works as long as you are consistent and thorough.
Step 4 - Subtract Existing Assets
Now subtract the assets your family would have access to without your life insurance. Your retirement accounts — 401(k) and IRA balances — would transfer to beneficiaries. Savings and investment accounts should be included. Any existing life insurance through your employer provides some coverage.
Social Security survivor benefits may also be available to your spouse and dependent children. The Social Security Administration website provides an estimate of survivor benefits based on your earnings record. These benefits can meaningfully reduce the coverage gap your life insurance needs to fill.
The formula so far is: income replacement plus debts plus final expenses plus education costs, minus existing assets and survivor benefits. The result is your net coverage gap — the amount of life insurance you actually need.
Step 5 - Review Your Number
Compare the number from your calculation to what you currently have in coverage. Most working adults with families need somewhere between $500,000 and $2 million in total coverage depending on income, debt, and family size. If your current coverage is significantly below your calculated need, the gap is worth addressing.
Get term life insurance quotes for your coverage gap amount. Term life is typically the most cost-effective way to cover temporary needs — the years while your mortgage is outstanding, while your children are growing up, while your retirement accounts are building. A 20-year or 30-year term policy purchased in your 30s is often surprisingly affordable.
Revisit this calculation every three to five years or after major life changes. A new child, a new mortgage, a significant income increase, or substantial new debt can all change your coverage need substantially. Your insurance should evolve with your life.