How Much Life Insurance Do You Need?
Summary: You know that taking out a life insurance policy is the best way to provide financial protection for your loved ones. Now is the best time to get life insurance. Click through to learn how much life insurance you need.
Your goal when taking out a life insurance policy is to provide enough financial protection so that your loved ones don’t have to worry about money if you should die unexpectedly.
How much life insurance you need, then, depends on how you want your survivors to use the money from a policy after you die. If your main concern is for your surviving spouse or partner to use your life insurance funds to pay off your home’s mortgage, you might need less life insurance than if you also wanted your policy to cover the costs of your children’s future college expenses.
A good rule of thumb in determining how much insurance you need: Calculate your total long-term financial obligations, including your remaining mortgage balance and the estimated cost of your children’s future college educations. Subtract your assets from this number. The resulting number is the amount that your life insurance must cover.
There are also some general rules of thumb that can give you a rough idea of how much life insurance you need.
Multiply your income by 10
The easiest way to calculate your life insurance needs: Multiply your annual income by 10.
Say you make $80,000 a year. According to this method, you’d need a life insurance policy of $800,000.
That’s an easy calculation. But it doesn’t take a more detailed look at your financial needs. You might need more than 10 times your income if you have a child with special needs, your spouse stays at home to take care of your children, you have very young children or you have children who plan to attend college.
Adding $100,000 for each child
Another rule of thumb is to purchase a life insurance policy equal to 10 times your income but to also add $100,000 worth of coverage for each child. This extra $100,000 can then help cover the costs of a child’s college education.
Say you earn $80,000 a year and have three children. You’d need a life insurance policy of $800,000 plus $300,000, or $1.1 million.
The DIME method
The DIME — debt, income, mortgage and education — method is a more detailed way to calculate your life insurance needs.
DEBT: First add up your debts, not including your monthly mortgage payment. Include the estimated cost of your funeral.
INCOME: Next, determine the number of years for which your family needs financial support from your policy. Multiply your annual income by this number.
MORTGAGE: Calculate the amount of money your survivors would need in order to pay off the rest of your mortgage.
EDUCATION: Finally, estimate the cost of your children’s future college educations.
Say your debts, minus your mortgage, amount to $30,000 and you expect your funeral to cost $10,000. Say that you also determine that your family will need support from your policy for 10 years and your annual income is $80,000. That comes to $800,000.
You might need $200,000 more to pay off the rest of your mortgage. If you have two children, you might estimate that it will take $100,000 each to provide them with a college education.
Adding all that together, you get $1.24 million, the amount of life insurance coverage that you’d need.
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