Those with financial dependents need life insurance, not only because will they leave behind sorrow and grief, but because there will be monetary burdens as well. Life insurance coverage ensures heirs aren’t left to carry that weight alone.

Domonique Rodgers of NC State says that, while many people understand the need for life insurance, they grow confused when it comes to deciding what amount to take out. Some policyholders take out enough to cover the debts that will outlive them, while others choose larger death benefits to leave a bigger nest egg behind.

Calculating the Perfect Amount of Life Insurance Coverage

In general, financial advisors suggest overestimating needs in order to leave wiggle room for unexpected expenses. The following four common methods can help wannabe policyholders decide how much coverage to take out.

Needs-Based Calculation

The needs-based calculation is a comprehensive method, considering a person’s family’s existing financial requirements.

Those utilizing this approach must figure out the amount of money necessary to meet immediate obligations, then add it to the sum that’s essential for keeping the household afloat.

Here’s how it works:

1. Add together outstanding debts such as mortgages, credit card balances, medical bills, and student loans, and include final expenses (i.e., funeral, and burial costs).
2. Estimate future expenses, including the cost of maintaining the family’s current living standards.
3. Subtract savings and other assets. Many online resources provide easy-to-use calculators for this purpose.

The resulting figure is the amount of life insurance coverage required.

The 10x Rule

The 10x rule is perhaps the simplest way of deciding how much life insurance is needed. It just requires multiplying the household’s highest annual salary by ten. Thus, if a policyholder makes $80,000 per year, they’d require coverage of $800,000.

Naturally, the advantage of using this method is its simplicity. After all, ten times any income will work wonders to help left-behind relatives maintain their standard of living.

However, it isn’t all sunshine and roses.

One of the disadvantages of the 10x rule is its limited use. Policyholders may have provided their household with childcare help and other vital, valuable resources unrelated to their income.

Plus, it isn’t detailed enough to guarantee financial security for beneficiaries.

The DIME Method

DIME stands for debt, income, mortgage, and education. While it’s a more complicated calculation than the 10x rule, it provides more security.

To follow this method, soon-to-be policyholders should add their family’s monetary needs in each category to determine the amount of coverage required.

Human Life Value

The final approach estimates the amount of money the policyholder would probably earn in their remaining years, assuming they die of old age. It’s a method that considers everything from a person’s gender, to age, to annual wages, to potential income increases, and more.

Here’s how it works:

1. Add up likely future income from now until retirement. Include potential wage boosts.
2. Subtract a somewhat-generous estimate for living expenses and income taxes.
3. Decide how long heirs will require the earnings.
4. Use a life insurance calculator to figure out the death benefit.

The Bottom Line

Acquiring the right amount of life insurance softens the monetary blow at the time of the policyholder’s death, so utilizing an in-depth calculation is key to guaranteeing security.