Buying life insurance is usually a selfless act, intended to allow your family to maintain their standard of living so they aren’t burdened financially while simultaneously grieving your loss. If your family depends on the income from your day job, you need life insurance and should consider it a necessity to your financial independence journey. This conversation can quickly become complicated by the several different types of life insurance. The most important consideration, however, is the amount of death benefit your family will receive when tragedy strikes, which is the focus of this post. There is no rule of thumb that works for everyone. The proper amount depends on what you want for your family.

My first time purchasing life insurance was not a positive experience. The agent I met with plugged some numbers into his computer and told me I needed a $350,000 term policy. After becoming more educated on the topic a few years later I was furious he risked the well being of my family by recommending such a small amount. My beloved bride and children would have been broke in less than 7 years. Now days I have nearly 6x the coverage originally recommended by this agent, albeit my finances have changed from five years ago.

As with several aspects of personal finance, there’s a disconnect between rules of thumb and individualized advice. My family would obviously be better off with $350,000 than nothing. My issue with this experience is that I was under insured because of taking the agent’s advice. This advice must have been based on rules of thumb because he didn’t ask very specific questions. My family is fortunate I didn’t die during this time. You should avoid any agent who recommends you buy a specific amount of insurance without first determining your intent for the insurance.

I’ve spoken with several people about their intent with life insurance proceeds and the spectrum of conversations have ranged from wanting to cover their funeral expenses to being able to retire their spouse for life. There’s no rule of thumb that covers such a wide spectrum of intent.

This is a topic that can be quickly over analyzed but I’ll do my best to simplify the conversation. I like acronyms because they can help make concepts more memorable. The acronym for life insurance is LI. According to Google, this is also an acronym for laughing inside. Since this is a somber conversation I doubt any of you are laughing inside. The purpose for life insurance proceeds is typically to pay off loans and replace income. The acronym for loans & income also happens to be LI. In other words, the primary purpose for LI is LI.

L is for Loans: First, tally up your debts and write this number down. It will likely be advisable for your spouse to pay off debts, especially consumer debts. Paying off mortgages can be debatable but life is simpler and less stressful without debt.

I is for Income: Next, calculate the present value of the future income you want to provide your family. This is determined by deciding how much annual income you want to provide, and for how many years you want this to last. Using these figures and also assuming an average investment and inflation rate is all you need to calculate this present value.

Crunching numbers to calculate the present value of this future income can get a little messy. I’ve attempted to make the next steps in this exercise as simple as possible by providing a chart for reference. The intent for the chart is to help you easily determine the amount of death benefit required to provide future income. My approach at simplifying this exercise consists of providing one number in which to multiply the desired annual income. The idea being that anyone could quickly calculate an appropriate amount of life insurance based on sound mathematical and financial principals.

To use this table you must decide how many years you want to provide income, as shown in column A. As you’ll see, I’ve chose to illustrate this in five year increments. After choosing the number of years, you must decide whether you want future income to be static or to adjust for inflation as reflected in column B or C. The inflation adjustment is considering the years in which your family is receiving income and does not account for the years leading up to an insurance claim. In other words, if you unexpectedly die in 10 years it doesn’t account for the impact of inflation during the next 10 years while you’re alive. The inflation I’ve chose to base this calculation is 2.5%.

When you’ve decided the number of years to provide income and whether this is to be adjusted for 2.5% inflation, the hard work is behind you. Now, all that’s left to do is multiply the annual amount of income you want to provide your family by the corresponding number in this table.

Consider an example of someone who wants to provide $50,000 annual inflation-adjusted income for 15 years. The calculation for this would be $50,000 X 12.7 = $635,000. If this person wanted to provide a static $50,000 for 15 years the calculation would change to $50,000 X 10.9 = $545,000.

Behind the scenes, I’ve used excel to calculate the discounted value of future income, then converted the discount rates into multiples. I’ve assumed a 5% average rate of investment return and 2.5% inflation. The math is sound and cannot be argued. What is debatable is the assumed investment return and inflation rate. I consider these reasonable assumptions but actual results could be higher or lower.

(A) No. Yrs. Income	(B) 0% Inflation Income Multiple	(C) 2.5% Inflation Income Multiple
*5	4.8	5.1
*10	9.2	10.2
15	10.9	12.7
20	13.1	16.1
25	14.8	19
30	16.1	21.6
35	17.2	23.9
40	18	26
45	18.7	27.8
50	19.2	29.4
55	19.6	30.8
60	19.9	32.1

* The table above provides linear calculations but markets don’t provide linear returns. Due to the unpredictable nature of these returns, you shouldn’t heavily rely on them for any time horizon under 10 years. Throughout history there have been decades with substantially varying market performance. For this reason it’s best to consider potential investment gains a bonus to your family and not a necessity for the income they require. Therefore, the five and ten year multiples in the table above assume 2% investment return. I know there are readers who will disagree with this approach. Admittedly, this is a conservative approach. The reality is that managing money for spend-down requires a much different approach than for accumulation. This is especially true when the spend down period is fewer than 10 years. A recession while you’re accumulating investments is an opportunity but during your spend down years is a risk. As you can imagine, it’s beneficial to buy at discounted values but harmful to sell at discounted values.

Simply add your total debts to the amount calculated for income and you’ll arrive at the proper amount of life insurance. Whatever number you arrive at, keep in mind insurance companies often provide cost breakpoints in $250,000 increments. If you calculate needing an amount slightly less than these increments, such as $925,000, it’s not only conservative to round up to $1,000,000 it might actually be the same price. Life insurance companies will also limit the number of years worth of income you can purchase. The company I’ve looked into limits the death benefit to 30 times current income but it could be different with each company.

Keep in mind this post makes specific investment and inflation assumptions. Actual results may vary so it doesn’t hurt to be conservative in your estimates. For investments to generate the assumed growth requires thoughtful management. Even then, investment returns are never guaranteed.