Is There Such a Thing as Too Much Life Insurance?

When embarking on the journey of adulthood, people have to make some hard decisions. Planning for the future that might not involve them is, sadly, one of those. Making plans about what’s going to happen after a person dies is necessary. Some people plan every detail, while others just get some life insurance and hope for the best.

So which option is better? Like taxes, death is inevitable, and one should prepare for it. But what does that entail?

People contemplating how much life insurance they need are, by no means, alone. There isn’t a simple answer to this question. What’s more, it’s usually preceded by some other, no less complicated queries. Do people even need life insurance? When is the right time to start thinking about buying it? And, finally, is there such a thing as too little or too much life insurance? 

When getting life insurance, people have to weigh a lot of different factors to come up with an answer to that question. Namely, to know how much of it they need, they have to factor in both what they have now and what they want to leave to their family. So they need to calculate how their current financial situation factors into their ideal future outcome. 

What Even Is Life Insurance?

Life insurance is an agreement between a person and an insurance company. The agreement states that the insured party will pay a monthly or yearly fee for a specific amount of time. In exchange, the company guarantees to pay a particular amount of money to the insured’s beneficiaries after the insured dies. 

Of course, people can also use life insurance as an investment and cash out before they die. Still, that’s not the point at the moment.

The entire purpose of life insurance is financial stability in case something goes horribly wrong. Every loss in the family is devastating. It’s emotionally charged, as people have to deal with the emotional fallout of losing someone. On top of that, they also have to handle additional expenses and loss of income. 

Let’s say a family of four lost the mother, who contributed to 50% of the family’s income. Depending on the cause of death, the now family of three has to deal with a lot of expenses. Aside from potential medical bills and funeral costs hanging over their heads, they have also lost half of their income in the future. 

That’s what life insurance is meant to compensate for. Life isn’t a Hollywood movie. No one gets life insurance so that they can get filthy rich after their loved one dies. People get life insurance so that their deaths don’t completely ruin their families and leave them shattered both emotionally and financially. 

The Benefits of Having Life Insurance 

If this isn’t reason enough, there are also other benefits to getting life insurance

As people approach middle age, they start contemplating the far future. That’s why they get insurance policies in the first place. They are scared that they might not qualify for them later in life.

One of the benefits of life insurance is that people almost always qualify. However, the older the person, the more significant the risk factor that the insurance company uses to calculate the premium. That’s why many insurance experts recommend getting life insurance as soon as possible.

People in their twenties think they have plenty of time before they start contemplating their own death. But the sooner they make plans, the better. Buying life insurance policies while young can secure a better deal. In fact, they might get a more affordable policy with a big payout. 

Furthermore, a lot of young people think they don’t need life insurance because they don’t have any dependents. They aren’t in the same situation as Carol from HR, who is the sole provider for her family of four. They are just Timmy from the front desk, a junior in the company. 

Timmy has no kids who will lose financial support. He doesn’t have a partner who will have to scramble to find another source of income, either. So why should Timmy bother with a life insurance policy when there’s no one to reap the benefits? 

Although Carol really needs the life insurance that will cover the bacon she has been bringing home, what Timmy keeps forgetting is that an Xbox isn’t the only thing he has to his name. He also probably has a lot of student debt. What’s more, there’s a strong possibility that Timmy, the front desk bachelor, doesn’t have any savings or an emergency fund. So what does that mean?

Well, if Timmy suddenly dies, his closest relatives will be stuck with the costs of the funeral and potential medical bills after his death. Just because Timmy doesn’t have kids doesn’t mean no one will suffer financial consequences after he dies. Even worse, if Timmy asked someone to cosign his student loan, for example, he would leave that person in quite a predicament after his unexpected, untimely death. 

Fortunately, those are all issues that a life insurance policy can solve.

Less Obvious Benefits

First of all, it’s really the easiest of the bunch to understand. Insurance can be hard to wrap one’s head around, but life insurance is quite straightforward.

Furthermore, it can have quite low premiums. If a person is young, healthy, and in a low-risk category, their premium can be surprisingly modest. 

Of course, one should always keep in mind that life insurance companies aren’t doing anything out of the goodness of their own hearts. It’s a profitable business, and the profit is the main objective. So people shouldn’t expect to get anything for nothing.

How Much Life Insurance Do People Actually Need?

Calculating how much life insurance a person needs to buy is a game of precarious juggling. There are lots of things to take into consideration. People need to weigh their financial responsibilities, expenses, and obligations against their assets. So it’s all about what one has and what they’ll have to compensate for (in case they die).

What Calculations Depend On

Dependents are the first thing to consider when contemplating life insurance. If a person has several dependents, they need to carefully assess everything they might need (financially) and buy enough insurance to cover that and more. 

Although the most critical factor, there are other things to think about. Getting life insurance is a sort of art. It’s a circus artform, some might say, as there’s a lot of juggling happening. 

Outstanding Debt

If a person has a lot of debt, they need to be aware of the fact that it won’t simply disappear into thin air after they die. It will, instead, burden their closest family members. 

Outstanding debt can cripple a family financially. So a good life insurance policy has to cover all the debt a person has. Calculating it begins by putting all debts on a piece of paper and making sure the policy covers at least those (and more, if possible). 

If the person is unaware of how much they owe (and to which establishments), they need to remedy that immediately. Calculating how much life insurance to buy is actually a perfect opportunity to get a grasp on one’s overall financial state. 

Income Replacement

A person who is the sole provider for their family needs to make sure they don’t end up broke after their death. That means getting an insurance policy that can cover the lost income for a significant period. 

The best course of action here is to calculate the yearly earnings and multiply them by 10 or 12. That way, all dependents can still have the same annual income. 

If there’s more than one earner in the family (whose death would mean a financial blow for the household), then they too should get a life insurance policy.  

Final Expenses

It’s a sad reality, but funerals can send someone into a financial ditch. On average, a funeral costs anywhere between $7,000 and $12,000

When an unexpected death of an uninsured person hits a family, covering the costs of the funeral becomes one of the greatest issues. It can’t be covered out of pocket money, which is why everyone should prepare for this inevitable expense. 

Generally speaking, most life insurance calculations should include funeral and other final expenses. Along with the previous two factors, funeral costs are almost a must-have when it comes to policy calculations — everything else is garnish.

Life Milestones

People who have the means to do so often include important life milestones in their calculations. They want to take into account their kid’s college tuition or other huge life expenses, such as weddings and honeymoons or gap years. 

Now, this is really something that is an add-on. But if they were alive, those people probably would participate in these and many other expenses. So while some might think it’s excessive, calculating the kid’s down payment for their first home is a must for some people. 

General Financial Plan

While some people plan to cover living expenses for their loved ones, others plan to make a more substantial financial cushion that will make life comfortable. Either way, the calculations should include everything they think they should provide for their loved ones, to the best of their abilities. 

Existing assets should also be taken into consideration. Savings, college funds, real estate that can be sold or rented — these are all assets that one should count in while calculating an ideal life insurance policy. 

Furthermore, people who have a kind enough employer that offers life insurance as a part of the benefits package need to consider that as well. Those policies probably won’t be enough, which is why they are contemplating getting life insurance in the first place. But they might be able to provide an additional financial cushion or cover some costs. That will lower the bottom line of the life insurance premiums and make things easier on the insured while they are still alive. 

How To Do the Actual Calculations

Once people know everything they need to consider, they can start calculating their life insurance. Several different methods allow them to do so. Admittedly, not all methods are ideal, but they are at least a solid start for those contemplating life insurance policies.

The “Times Ten” Method

Already mentioned, the “times ten” method is one of the most common ones. It requires the person to take out an insurance policy that has a payout equal or higher than ten times their annual salary. So for example, if a person earns $50,000 per year, their insurance policy should come up to $500,000. 

Alternatively, people also use a similar method but with a different focal point. They calculate their annual income by taking into account the number of years they have left until retirement. So in that case, the same person who earns $50,000 per year and has 25 years until retirement, needs a payout of $1,250,000. 

Some financial experts say that these methods are outdated because inflation can get out of hand. This is a particularly unstable time, and the economy is constantly fluctuating — so they might have a point. 

This method only takes into account the loss of income. As previously mentioned, people need to consider a lot more than that. 

First of all, they might have assets that can change the outcome significantly. Properties, savings, and emergency funds, as well as pre-existing policies, all affect the financial situation of the family once their breadwinner dies. 

Furthermore, this method doesn’t give people what they are looking for — an exact amount of money they need. For example, it makes it impossible for a stay-at-home parent to calculate how much insurance they require. 

How much is the work of a stay-at-home parent worth? How does one calculate all the things they’ll have to compensate for if the stay-at-home parent dies? They cook, clean, care for the kids, Uber them around, work as a stylist, counselor, a financial planner, etc. How does one calculate and figure out how much money will be enough to cover all that? 

An Upgraded “Times Ten” Method

Similar to the previous one (and also with the same downfalls), this method requires a person to follow the “times ten” method and then add $100,000 for each child in their care. 

The main idea is that the extra $100,000 will cover the college expenses and save the child from massive student debt. 

Again, although solid, this method isn’t infallible, as there’s a lot it doesn’t take into account.

The DIMEF Formula

Succeeding where the previous two methods failed, the DIMEF formula makes people take a closer look at their financial situation and reconsider their expectations. The calculations will be a bit more extensive, but the result might provide everything a person is looking for out of an insurance policy. 

Every family has different needs and financial habits. Two families with the same annual income might need two different insurance policy payouts. The DIMEF method allows for these differences and takes into consideration almost all previously discussed factors.

DIMEF stands for debt, income, mortgage, education, and funeral. So aside from the garnish, it makes people take into account all major life expenses they need to cover for their loved ones with their insurance policy. 

Yet, although a lot better than the previous two, this method still doesn’t take into account previous assets and existing policies. Even worse, it does nothing to help stay-at-home parents calculate how much life insurance they need.

The LIFE Approach

The yin to the previous methods’ yang, the LIFE approach makes people consider everything. 

By following the LIFE method, a person is supposed to apply the DIMEF method and calculate how much money they need to cover any debt, funeral, and education costs, as well as to supplement the lost income. 

Then, once everything is accounted for, people should subtract the money they already have (in any form) — savings, real estate, and other assets. Their dependents can liquidate these assets immediately after their death. That money should cover at least a portion of the costs they’ll be facing. 

The third and final step of the LIFE approach is to factor in all existing life insurance and other insurance policies. 

Pro Tips On Life Insurance

Learning the Lingo

People often get confused by the terminology of insurance. Who’s the buyer, and who’s the owner of the policy? What’s a policy rider? What are dividends, and are they the same as payouts? 

These and many more questions often trouble first-time insurance buyers. What’s more, they overwhelm and confuse them. 

To avoid that, people should do their research and figure out the basics of life insurance. At the very least, they should get familiar with the lingo so that they don’t end up feeling like a fish out of water once they go to talk with a life insurance agent. 

Shopping Around

Insurance agents have a way of swaying people to their side. They usually have a well-thought-out pitch that’s meant to lure as many potential customers as possible. Thus, a lot of people fall victim to buying insurance from the first agent they talk to. What’s more, they end up convinced that the deal they got is fantastic. 

Although that might be true, it’s also a good idea to shop around and talk to several agents. Knowing all options before making a decision is always the best policy.

Choosing the Best Type and the Appropriate Length

After determining how much life insurance they need, people should also figure out the best type of insurance policy to go for. Understanding the difference between cash value and term life insurance policies is almost as important as knowing how much life insurance to buy in the first place. 

Furthermore, the length of the policy is also critical. Younger people who are just starting out in life, getting married, or taking out loans to buy their first home, should consider longer policies. The same goes for those who are the sole providers in sole-income households. 

On the other hand, middle-aged people and those crawling slowly but surely toward retirement should consider their overall health and goals in life. Everyone thinks they’ll live a long time, but unfortunately, that isn’t always the case. 

Still, this doesn’t mean that middle-aged people should buy short policies only. If a person outlives their policy, they might not get any money out of it. So people really need to think hard about the length of their policies. 

The Right Amount for You

Simply knowing that a person needs life insurance and going out and buying it isn’t the best course of action. Before making such a monumental decision, everyone should weigh their options. They need to measure their needs and capabilities against one another. Then, they should calculate the exact amount of life insurance that will be ideal specifically for them. 

As a parting tip, here’s another piece of wisdom — if possible, people shouldn’t embark on this journey alone. They should consult their loved ones or life partners and make these difficult decisions together. 

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