If you’ve purchased life insurance, you’ve taken an important step in protecting your family’s financial future. Such coverage can help your loved ones maintain their living standard in the event you should pass away prematurely, or at least eliminate some of the stress of making ends meet.
But how do you know if you have enough coverage? That can be a complicated question. And possible answers are likely to change over time. Life insurance is not a "set it and forget it" financial solution. As circumstances change, so do your coverage needs. You may need to revisit the amount (and type) of life insurance coverage you have if:
- Your family has grown
- Your stay-at-home spouse is not insured
- You only have group life insurance through work
- Your income rose
- You have significant debt
- Your financial goals have changed
Am I already underinsured?
There is no one right answer, said James Guarino, a financial planner and managing director with Baker Newman Noyes in Boston. The appropriate death benefit amount differs for everyone depending on their assets, income, and financial goals.
Families with enough personal savings to cover their expenses without an income, he said, may not need life insurance coverage at all, while single-earner households might need enough coverage to replace the breadwinner’s annual salary until retirement.
In double-income households, or those in which a stay-at-home spouse would be able to earn an income if the breadwinner passed away, the insured may only need the death benefit to provide for a specific need, like paying off the mortgage or their child’s college education.
Underinsurance is common. According to Life Happens, a nonprofit consumer education group, roughly one in five consumers with life insurance coverage say they do not believe they have enough.1 Some started off with sufficient coverage, but failed to increase their policy amount as their income and financial obligations grew. (Calculator: How much life insurance do I need?)
Others are well aware of their coverage shortfall, but either can’t (or think they can’t) afford the amount they need or choose to apply their disposable income elsewhere. Often, they make a choice based on faulty assumptions about cost. In one study, when asked to estimate the cost of a $250,000 20-year term life policy for a healthy 30-year-old, over half of the respondents said more than $500 per year. The average cost of such a policy is closer to $160 per year.2
Of course, the “right” amount of coverage is relative. People purchase life insurance for different reasons. Often, it’s used to replace the policyowner’s lost income if he or she should die unexpectedly, so their surviving spouse and kids can pay the bills. Others buy whole life insurance to provide for a spouse in retirement or cover long-term care expenses. And some use it as an estate planning tool to pass money along on a tax-favored basis to their heirs. (Learn more: Survivorship insurance)
If you added a new family member to your flock, it may be time to increase the size of your life insurance policy. According to the most recent government estimates, it will cost the average middle-income, married couple nearly $234,000 to raise a child through age 18. That does not include the cost of a college education.3 If you aim to cover your kid’s college education, braces, and future wedding ceremony in the event that you are no longer around, those expenses should be factored into your death benefit as well.
It’s a common misconception that stay-at-home parents do not need life insurance coverage. True, they don’t produce an income. But if they should pass away when the kids are still young, the breadwinner would need to pay for day care or a nanny. The monthly expenditure for house-cleaning services, tutors, and prepared meals may also go up. According to Child Care Aware of America, the average cost of center-based infant day care ranges from $420 to $1,420 monthly, depending on where you live.4 (Learn more: Stay-at-home parents and the need for life insurance)
One more reason to insure a stay-at-home parent: It protects the earnings potential of the breadwinning parent, so he or she would not have to scale back hours or take a less-demanding job to keep their household afloat.
Employer-provided life insurance is a great benefit for many working Americans, but the amount provided may not be sufficient to protect your family from financial loss in the event that you should pass away during your working years. Group life insurance is typically not portable, either. You may not be able to take it with you if you quit or lose your job, which puts you in the position of having to purchase private insurance when you are older. (Age impacts your premium.) And, if you develop a health condition between now and when you leave your job, you may no longer be eligible for the lowest rates, or qualify for private insurance at all.
If you only have employer-provided group life insurance, you may want to consider supplementing it with a private policy. Indeed, as group insurance rates increase over time, individual coverage may be less expensive per $1,000 of coverage over the long term.
To estimate how much life insurance coverage his clients should have, Guarino said he starts by calculating the cash-flow needs (through retirement) of each spouse and any dependent children with the assumption that the other spouse has passed away. He then compares that figure with their cash flow sources. “The resulting shortage is what we attribute to their life insurance shortfall and the recommended amount of life insurance they should obtain,” he said in an interview. Guarino then discusses different types of life insurance options, including term life coverage and permanent life policies, which serve different needs. (Learn more: Term vs. perm life insurance: 3 considerations)
A bigger paycheck is a good thing, but if your family depends on your income to cover their living expenses, your life insurance coverage needs to keep up. It may be time to review your coverage needs if your salary has grown substantially since you purchased your policy, said Larry Singer, an insurance agent with New Jersey Life & Casualty Associates in Livingston, New Jersey.
Remember, the purpose of life insurance is to provide a big enough safety net that those you leave behind would be able to maintain their lifestyle if you were no longer around. If that lifestyle has changed, your coverage amount should, too.
“A $1 million policy may sound like a lot, but what that really does is provide your beneficiaries with $200,000 a year for five years, or $100,000 a year for about 10 years,” he said, noting policyowners need to calculate their financial need for a realistic estimate of how much coverage they may need. A term life policy, which provides coverage for a specific length of time when there might be a particular need, can be an affordable way to protect your family with a bigger death benefit in the event that you should die prematurely, he said.
You may need more coverage if you have private student loans, mortgages, medical bills, or other debts and someone else (spouse, parents) cosigned on your behalf. Indeed, any individual who cosigns for a loan is liable for repaying the balance in full if the original borrower defaults or dies.
Failure — or inability — to do so can tarnish their credit rating and land them in legal trouble.(Cosigners are generally not responsible for paying off their partner’s federal student loans, but that does not necessarily hold true for private student loans.) To protect your benevolent cosigner, you might consider purchasing enough life insurance coverage to at least pay your debts in full should you pass away.
Many couples purchase budget-friendly term life insurance when they start a family, primarily because it costs less. But as their income and financial goals change, they may no longer have the kind of protection that’s right for them. Term life insurance provides coverage for a specific length of time. The beneficiaries receive the death benefit only if the policyowner dies before that term is up.
By contrast, a permanent (or whole) life insurance policy costs more because it guarantees a death benefit to your beneficiaries when you pass away at any age, as long as you maintain your policy. It may also enable policyowners to accumulate cash value that can be used to help meet their retirement and other long-term accumulation goals. If you currently have a term life policy, but wish to leave a legacy to your heirs (or a favorite charity), you may not have the type of coverage you need. (Learn more: What policyowners should ask about term-perm conversions)
“When you’re younger, it’s hard to grasp how your brain changes as you age,” said Singer. “In your 60s, when you have grandkids or the prospect of grandkids, you start thinking in terms of legacy.”
Underinsurance is common in U.S. households. To be sure your family has the protection it needs, review your coverage regularly to ensure that you have both the amount and the type of policy that’s right for you.
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1 Life Happens, “Key Findings for the 2018 Insurance Barometer Study,” April 10, 2018.
2 LIMRA, “2019 Insurance Barometer,” April 1, 2019.
3 U.S. Department of Agriculture, “The Cost of Raising a Child,” Jan. 13, 2017.
4 ChildCare Aware of America, “The US and the High Cost of Child Care: 2018: A Review of Prices and Proposed Solutions for a Broken System,” 2019.