One reason for choosing a life insurance policy is to figure how much your dependents will need after you’re gone. In order to choose the face value (the amount your policy pays if you die) of your life insurance you should consider the following:
- How much debt you have: All of your debts must be paid off in full, including car loans, mortgages, credit cards, etc. If you have a $200,000 mortgage and a $4,000 car loan, you need at least $204,000 in your policy to cover you debts (and possibly a little more to take care of the interest as well).
- Income Replacement: One of the biggest factors for life insurance is for income replacement, which will be a major determinant of the size of your policy. If you are the only provider for your dependents and you bring in $40,000 a year, you will need a policy payout that is large enough to replace your income plus a little extra to guard against inflation. Just to replace your income, you will need a $500,000 policy. This is not a set rule, but adding your yearly income back into the policy (500,000 + 40,000 = 540,000 in this case) is a fairly good guard against inflation. Remember, you have to add this $540,000 to whatever your total debts add up to.
- Future Obligations: If you want to pay for your child's college tuition you will have to add this to the amount of coverage you want, which would be about another $100,000
Adding everything together, you will probably want a policy for $840,000 ($540,000 to replace yearly income + $200,000 for the mortgage expense + $100,000 university expense).
Once you determine the required face value of your insurance company, you can start shopping around for the right policy (and a good deal).
Obviously there are other people in your life who are important to you and you may wonder if you should insure them. As a rule, you should only insure people whose death would mean a financial loss to you. If you have a spouse or partner that also is a contributor to the family income, then it would make sense to go through the same exercise to determine the face value of the policy.