Life Insurance: How Much and What Kind To Buy

The purpose of life insurance is to provide a source of income, in the case of your death, for your children, dependents, or other beneficiaries. Life insurance can also serve other estate planning purposes, such as giving money to charity on your death, paying for estate taxes, or providing for a buy-out of a business interest.

Whether you need to buy life insurance depends on whether anyone is depending on your income. If you have a spouse, child, parent, or some other individual who depends on your income, you probably need life insurance. You might also need life insurance for estate planning or business succession planning purposes.

Related Guide: Please see the Financial Guide: ESTATE PLANNING: How To Get Started.

Typical situations & needs

• Families or single parents with young children or dependents. Younger children generally imply higher insurance needs. If both spouses earn income, insure both, proportionate to income. If funds are limited, prioritize the primary earner. If a spouse doesn’t work outside the home, consider coverage for the services they provide (child care, housekeeping, bookkeeping).
• Adults with no children or other dependents. You may need less coverage but still plan for burial expenses, debts, and an orderly financial transition. Increase coverage if your spouse would face hardship without your income or savings are limited.
• Single adults with no dependents. Typically, coverage for burial expenses and debts is sufficient unless using insurance for estate planning purposes.
• Children. Generally only enough to cover burial expenses and medical debts; in some cases, a policy may be used as a long‑term savings vehicle.
• Retirees. Often less need unless for estate purposes. Consider income for a surviving spouse, burial/final medical costs, and debts.

Determining how much insurance to buy requires time to calculate your household’s annual expenses as well as your assets, debts, and other income sources. Find the amount you need before choosing a policy type—having enough is more important than the exact product.

A common rule of thumb (5–7× salary) can be a starting point, but it’s no substitute for a tailored calculation. The ideal coverage allows your dependents to invest the proceeds and maintain their living standard without touching principal.

Worksheet overview

1. Annual Income Needed. Tally recurring expenses (housing, utilities, food, clothing, transport, child/dependent care, recreation, other) and annualize them.
2. Other Annual Income Sources. Include survivor earnings, estimated investment income, Social Security, pension income, and other income. (SSA estimates can be requested via 800‑772‑1213.)
3. Shortfall. Subtract other income from income needed.
4. Proceeds Needed. Divide the shortfall by an after‑tax return (e.g., 4%, 5%, or 6%) to estimate the lump sum needed to generate that income.
5. Lump‑Sum Expenses. Funeral, final medical, estate/probate (≈5% of estate for simplicity), potential estate/inheritance taxes, emergency fund (3–6 months), debts to pay off, education, and other one‑time costs.
6. Interim Proceeds. Add proceeds needed (step 4) and lump‑sum expenses (step 5).
7. Assets & Other Insurance. Subtract liquidatable assets and one‑time death benefits (group life, other life insurance, pension death benefits, cash/savings, retirement lump sums) from interim proceeds.
8. Total Insurance Needed. The result is your estimated coverage requirement.

There are two broad categories: term and cash value (whole life, universal life, or other permanent types). For many people age 40 or younger, term is usually less costly. Many term policies are convertible to permanent without a medical exam.

Term insurance variants

• Renewable. Automatically renews (e.g., 1, 5, 10, 20 years) with premiums rising at renewal due to age. Often renewable up to ~age 70.
• Re‑entry. Requires a medical exam after a period or higher premium.
• Level. Premium guaranteed to stay the same for a set period; most modern term is level term.
• Decreasing. Face amount declines over time (often matched to a mortgage) while premiums remain level.
• Return of Premium. Higher premiums; returns premiums if kept to term.

Cash value (permanent) types

• Whole Life. Lifetime coverage with level premiums, guaranteed cash value growth, potential dividends (participating policies). Loans available against cash value.
• Universal Life. Flexible premiums and death benefit; cash value grows at a fixed minimum rate; can borrow/withdraw but must monitor funding to avoid lapse.
• Variable Universal Life. Cash value invested in subaccounts you select; higher upside and risk.
• Variable Whole Life. Death benefit and cash value tied to investment fund performance; higher potential reward and risk.

Feature snapshot across common policy types:

Premiums vary across insurers. Companies place applicants into risk groups (preferred, standard, substandard, or uninsurable) based on health, lifestyle, and other factors. A label at one company may differ at another—so shop around. Once approved, coverage cannot be dropped as long as you pay your premiums.

• High‑risk jobs/hobbies → substandard rates; terminal illness → generally uninsurable.
• Chronic conditions (e.g., diabetes, heart disease) often insurable at higher premiums.
• Compare multiple quotes; underwriting categories differ by insurer.

Many states require cost indexes to help compare policies: the net payment index (cost of carrying for 10/20 years; lower is cheaper) and the surrender cost index (focus on cash value; can be negative—lower is cheaper). For universal life, compare cash value growth and cash surrender value; given equal premium, death benefit, and interest, the policy with the higher surrender value is generally better.

Questions to ask

• How do cash values accumulate? (Earlier/faster build‑up is usually preferable.)
• How has the policy performed historically vs. projections and peers? (See Best’s Review, Life & Health.)
• Are special features valuable to you or just bells and whistles?
• What are the company’s ratings (A.M. Best, S&P, Moody’s)? Aim for top‑tier stability.