Why many Americans remain underinsured

[UNITED STATES] As of January 2024, 49% of American adults do not have life insurance, and 42% say they either need a policy or require more coverage. For those with dependents or financial obligations, inadequate life insurance can leave loved ones vulnerable.

Before delving into how to calculate your life insurance needs, it’s important to understand why life insurance exists in the first place. Life insurance is designed to provide financial support to your dependents in the event of your death, helping to ease the financial burden during a difficult time.

What “adequate” coverage looks like will differ from one person to another. For example, a household’s primary income earner may need a policy large enough to replace lost wages, while others might need to cover debts such as a mortgage through specialized policies like mortgage protection insurance.

Grasping this broader role of life insurance is key to understanding how much coverage you actually need.

A Growing Gap in Coverage Among Younger Americans

Recent trends reveal that younger generations are particularly underinsured. A survey by the Life Insurance and Market Research Bureau found that just 28% of millennials have life insurance, compared to 50% of baby boomers. This disparity is concerning, especially given that millennials often face significant financial commitments, such as student loans and the costs of raising young families. The data underscores a need for greater awareness and education around life insurance in younger age groups.

How to Estimate Your Life Insurance Needs

The 10x Income Rule

A commonly used starting point is to multiply your annual income by 10 to 15 times. For example, someone earning $75,000 annually might consider a policy ranging from $750,000 to $1.125 million. If you have children, experts often recommend adding an additional $100,000 to $150,000 per child to help cover future college expenses.

While this method offers a quick estimate, more personalized approaches can provide a better picture of your true coverage needs.

Accounting for Inflation

It’s essential to factor in inflation when determining how much coverage to buy. As the value of money diminishes over time, a policy that seems sufficient today might fall short in the future. Financial planners typically recommend using an annual inflation rate of 2% to 3% in your calculations to help ensure future expenses are covered.

A More Comprehensive Approach: The DIME Formula

For a more tailored calculation, consider the DIME method, which breaks your financial needs into four categories:

• Debt: Total outstanding obligations, excluding your mortgage, plus potential end-of-life expenses.
• Income: Your annual income multiplied by the number of years your dependents will rely on it. For families with young children, consider the number of years until your youngest reaches adulthood.
• Mortgage: The remaining balance on your home loan, including any second mortgage or home equity line of credit.
• Education: Estimated education costs for each child—typically between $100,000 and $150,000.

After totaling these, subtract any savings or existing life insurance to determine your coverage gap.

Life Insurance and Estate Planning

Life insurance can play a pivotal role in estate planning, especially for high-net-worth individuals. It can provide liquidity to cover estate taxes and other costs, helping heirs avoid selling assets. Additionally, policies can be structured to benefit specific individuals or charitable organizations. Consulting with an estate planning attorney can ensure your life insurance aligns with your overall financial strategy.

Online Tools Can Help

Several online calculators, like the one from the nonprofit Life Happens, offer a quick way to estimate your life insurance needs. While these tools won’t replace a financial advisor’s personalized advice, they can provide a useful starting point.

For instance, we used Life Happens’ calculator to run numbers for a hypothetical individual earning $60,000 annually, living in New York with two young children, no debts, and $4,000 in monthly expenses. The results offered a ballpark estimate of the coverage they’d require for 10 years of income replacement.

What to Consider Before Purchasing a Policy

Review Existing Coverage

Before buying a new policy, evaluate any life insurance already in place, such as group coverage through your employer. While job-based insurance typically ends with your employment, it can provide valuable support in the meantime, including coverage for funeral costs.

Protecting Your Loved Ones’ Livelihood

Life insurance replaces income to help your dependents maintain their standard of living. It covers essentials like rent, groceries, and transportation. Even non-working family members, such as stay-at-home parents, can benefit from coverage that offsets childcare and household labor costs in their absence.

Debt and Final Expenses

For those with shared financial responsibilities, life insurance can relieve co-signers or family members from the burden of outstanding debts. It also covers funeral or cremation costs, allowing loved ones to focus on healing.

Future Financial Goals

Your calculations should also account for future financial needs, such as funding your children's college education or caring for aging parents.

Why Professional Advice Matters

Speaking with a financial advisor, estate planner, or accountant can help you determine the right policy for your needs. As life evolves—marriage, children, career changes, or retirement—so too will your insurance requirements.

A professional can also help you evaluate whether you need term life, permanent life, or supplemental policies like long-term care or disability insurance.

When and How to Adjust Your Coverage

Life insurance needs are not static. Major life events—like having a child or paying off your mortgage—should prompt a review of your coverage. Increasing coverage may require new medical exams or underwriting, while reducing it could come with restrictions.

For those seeking more flexibility, universal life insurance may be an option, allowing policyholders to adjust premiums and death benefits over time.