How to Choose the Right Amount of Life Insurance

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For many people, the idea of buying life insurance brings to mind the annoying insurance agent Ned Ryerson in the 1993 comedy “Groundhog Day.”

“Do you have life insurance?” Ryerson asks the Bill Murray character, Phil Connors. “Because if you do, you could always use a little more. Am I right or am I right?”

More Americans are realizing that Ned may be right, especially considering the COVID-19 pandemic.

The number of life insurance policies sold jumped jumped 11 percent in the first quarter of 2021, compared with last year, according to LIMRA, a financial services trade association. And nearly one-third of consumers say COVID-19 concerns have made it more likely that they will purchase life insurance coverage in the next 12 months, a recent LIMRA survey shows.

That’s because life insurance can provide a crucial financial safety net if you have loved ones to support. Millennials are especially concerned about leaving their families in a difficult situation if they die, according to the survey, with 43 percent saying they were likely to purchase coverage.

Even so, many Americans who would benefit from coverage still don’t have it. Recent industry data (PDF) show just 52 percent of adult Americans report having life insurance, down from 63 percent in 2011.

There are varied reasons for the coverage gap. Life insurance is still not a priority for many families, who are focused on paying immediate bills, such as rent or groceries, as well as struggling to recover from the pandemic.

Many people put off buying a policy because they believe they have sufficient coverage through their employer, says Tom Fredrickson, a fee-only financial planner in Brooklyn.

“The problem is that your employer life insurance benefit is usually limited, perhaps one or two times salary, and you often lose it when you change jobs,” Fredrickson says.

So if you have family members who depend on you, take the time now to review your life insurance needs.

Given the complexity of these decisions, it’s a good idea to consult with a fee-only financial planner—one who has no direct interest in selling insurance—to help calculate your coverage needs and how to choose a policy.

You can find tips for choosing a choosing a financial adviser or a working with a fiduciary. And to help you get started, here are answers to three frequently asked questions about life insurance.

How Much Coverage Do You Need?

When it comes to figuring out the right amount of life insurance to buy, it’s tempting to rely on rules of thumb, such as purchasing a multiple of your annual income—say, 10 to 15 times your salary—as a death benefit. That would at least ensure that your family has resources that should last for a while.

But chances are, online tools or a rule-of-thumb approach won’t provide the best answer for your financial situation, says Steve Parrish, Co-Director of the Center for Retirement Income at the American College of Financial Services.

“It’s important to use your own numbers and look at the specific obligations and needs your family will have,” Parrish says.

If you have young children, for example, and your stay-at-home spouse needs to return to work, you may want to fund additional child-care costs, as well as college educations. You may have mortgage and credit card debt to pay off, additional medical costs, or elderly parents who need financial support.

It makes sense to subtract any emergency savings or current insurance coverage (if you intend to keep it) from your financial needs. But you will also want to increase the coverage amount to account for future inflation and salary increases.

What's the Cheapest Way to Buy a Policy?

The simplest and cheapest option is term life insurance. You pay a yearly premium in return for a fixed death benefit that goes to your beneficiary if you die while the policy is in force.

With a term policy, you get the most benefit per premium dollar, says Steven Weisbart, former chief economist of the Insurance Information Institute, an industry group that provides consumer information.

That frees up more of your cash flow for other expenses, such as for your kids’ college educations or for retirement savings.

For example, a 35-year-old nonsmoking man in good health might pay as little as $21 per month, or $252 per year, in premiums for a $500,000, 20-year level term policy, according to Quotacy, an online life insurance brokerage company. Upping that amount to $1 million would run $34 per month, or $408 per year.

By contrast, a 35-year-old healthy, nonsmoking woman might pay somewhat less—$216 per year for a $500,000 policy, or $360 for $1 million in coverage.

If you have a life insurance benefit at work, you can consider increasing that coverage, if it’s an option. But be sure to shop around first, Fredrickson says, because it may be more affordable to buy it separately.

The sooner you make the purchase, the better, because the cost of premiums rises as you age and your risk of having health problems increases, says Jeremy Hallett, CEO of Quotacy.

A 45-year-old healthy, nonsmoking man might pay $1,056 per year for a $1 million policy, and a 55-year-old may be charged $2,664, Quotacy’s data show.

Term life insurance does have a downside: It’s limited. A policy is typically purchased for a 10-, 20-, or 30-year term—after that, the coverage ends and you don’t get any of your money back.

When your term policy expires, you often have an option to convert it to permanent, or cash-value, insurance, which combines a death benefit with an investment account, as we explain below.

By converting, you avoid having to get a medical exam, as with a new policy. But this option will be more costly than your current term coverage.

Should You Consider Cash-Value Insurance?

With a permanent life insurance policy, you generally get a death benefit as well as a savings or investment component. There are different types of cash-value coverage, including whole life and universal life, which offer varying investing options, carry higher costs, and are often complicated.

With whole life, for instance, only a portion of your premium goes to the death benefit, so you will generally have to pay a higher premium to get the equivalent benefit you would with a term policy. For example, that healthy 35-year-old man purchasing $500,000 in coverage might pay $4,488 per year for a whole life policy, vs. $252 for term, Quotacy says.

Granted, a portion of your premiums would go toward the savings or investing account. But to come out ahead you will need to hold a cash-value policy for many years, says Glenn Daily, a fee-only life insurance adviser in New York City. If you surrender your policy in the first few years, before the value has built up, you may get little or no money back.

Permanent insurance may be worth considering for some people, such as those who want to provide for grandchildren or special-needs family members. But before you consider one of these policies, first make sure you have maxed out all your tax-deferred savings. “Fully funding your 401(k) and Roth IRA will give you growth with the most flexibility,” Daily says.