How much life insurance do I need? Three ways Canadians can decide

You’ve been putting it off for far too long and you know that you need to make a decision. 

But when it comes to purchasing a life insurance policy, you’re finding it difficult to determine which type is best — term or permanent — and the amount of coverage that will be adequate. 

How do you ensure that there’s enough money to keep your family financially protected if the unlikely happens — without becoming under- or over-insured?

Thankfully, some straightforward methods exist for estimating how much life insurance you’ll need. Here are some factors to consider, along with three of the most popular calculations you can use.

How much life insurance do I need? The basics

Life insurance protects the people who depend on you financially. It helps your partner, children, aging parents, or other loved ones cover day-to-day expenses if you pass away before they do.

If you don’t have people to protect or large debts, such as a mortgage, to cover, your money is likely better spent building retirement savings or an emergency fund. 

You also probably don’t need life insurance if you have enough savings to pay for the expenses that insurance would cover.

Other factors to consider when calculating how much life insurance you need include:

1. Your overall financial plan

View life insurance as part of your overall financial strategy. Think about your family’s current and future expenses, your income, and how many assets your family has. 

Also, consider unpaid contributions, such as a stay-at-home parent who handles childcare and housework. If this parent were to pass away, the remaining parent would have to pay someone to provide similar services at an additional cost.

2. Your age

You’ll want to purchase life insurance if you have somebody depending on you for financial support. Usually, this is when you get married, have a common-law partner, or start having children. 

There is a bonus to buying coverage when you’re young: you’re able to lock in a low monthly rate for the entire term of your policy, whether that’s 10 years, 20 years or more.

3. Your health

If you’re young and healthy, you’ll likely outlive your policy. That means you’ll pay a lower life insurance policy premium. 

Most term life insurance policies offer the same fees throughout the life of the term. So even if you develop health problems as you age, your premium won’t increase.

4. Your policy’s affordability

You need a life insurance policy that fits your monthly budget. Otherwise, you risk not being able to pay your policy’s premium. If your policy lapses, you could leave your family with a huge financial burden if you were to die unexpectedly. 

Keeping life insurance affordable means purchasing the right policy without overpaying. Unfortunately, PolicyMe survey findings reveal that 49% percent of Canadians have the wrong type of life insurance, namely unnecessary, expensive, and confusing policies. To lower the cost of your policy premiums, shorten the term or lower the coverage amount.

Can’t afford the amount of coverage you need right now? Buy a smaller life insurance policy rather than postpone buying it altogether. After all, giving your family a small financial safety net is a whole lot better than leaving them with no safety net at all.

What is life insurance used for?

Unlike other types of insurance, life insurance provides your beneficiaries with a direct payout in the event of your death. As a result, they can use the lump-sum, tax-free payment however they wish.

Common uses for life insurance include:

• Funeral costs: Lawyer fees and other expenses associated with settling your estate can cost thousands of dollars. 
• Paying off outstanding debts: Your estate is responsible for paying outstanding debts, including car payments, mortgage, loans, or credit cards. 
• Children’s expenses: Life insurance can cover shelter, food, and clothing for children until they reach an age of independence. 
• Beneficiaries’ ongoing living expenses: A lump-sum payment can go toward rent, utilities, food transportation, child care, and other household expenses.
• Any unique family needs: Families may choose to cover the cost of a caregiver for an aging parent or children’s education.

How much is life insurance going to cost me?

You’ve got many options for buying life insurance, but term life insurance policies are the most popular. This type of insurance is simple and is the most affordable choice for most individuals.

Permanent life insurance (such as whole or universal life) covers you for your entire life and so your premiums are higher. 

Term life insurance provides financial coverage for your beneficiaries over a specific period — for instance, until your mortgage is paid off. In other words, you’re covered financially for the period when your family needs it the most.

You can choose a coverage amount that’s anywhere between $20,000 and $10 million. The average life insurance protection per household in Canada is $442,000. 

The cost of your monthly premium depends on your age, gender, health, coverage amount, and policy length. For example:

• $21.39/month for $500,000 in coverage for 20 years (30-year-old non-smoking woman)
• $30.13/month for $500,000 in coverage for 20 years (30-year-old non-smoking man)

Keep in mind that these are estimated PolicyMe rates from 2021, which can go up based on individual health history.

PolicyMe’s online life insurance checkup offers a morepersonalized estimate of how much life insurance will cost you. In five minutes, you’ll be able to see the coverage amount and policy length you need to protect your family.

How to calculate how much life insurance you need

To estimate how much life insurance you require, use one of the following three methods:

Method #1: Multiply your income by 10 to 15

A general rule of thumb is to multiply your gross income (before tax) by 10 to 15. For example, if you make $80,000 per year, your life insurance policy should be at least $800,000 ($80,000 x 10 = $800,000).

Keep in mind that this is one of the simplest calculations for life insurance estimates. It doesn’t take a detailed look at your family’s financial requirements or current liquid assets. As a result, this method should be only a starting point when calculating your life insurance needs. 

Method #2: Use the DIME Method

The DIME formula (Debt, Income, Mortgage and Education expenses) offers a more accurate life insurance calculation than the previous two methods. Add up the following four amounts:  

1. Debt: What are the total outstanding debt and future funeral costs that you’re leaving behind for your family to deal with?
2. Income: How many years will your family need the equivalent of your income to cover financial expenses?
3. Mortgage: What’s the outstanding amount left on your mortgage?
4. Education: What will it cost to cover the price of higher education for your children?

The DIME Method provides a more well-rounded view of your financial needs then Method #1. That said, it overlooks current financial resources your family could use for expenses, such as savings or your partner’s income. Due to this, this method’s calculation could leave you with more insurance than you need.

Method #3: Add up your financial obligations and assets

For the most comprehensive way to determine appropriate life insurance coverage, calculate your current financial obligations and resources, including:

1. Income replacement: Provide enough finances for current and future expenses by multiplying the salary you want to replace by the number of years you want to replace it for.
2. Your mortgage balance: Include this to allow your family to remain in their home stress-free. That said, if you’ve accounted for paying for your mortgage in step one (income replacement), skip this step.
3. Other large debts: Calculate any large outstanding obligations that would create financial hardship for your family.
4. Children’s postgraduate education: Set your kids up for success by ensuring there’s money available for their tuition, accomodation, and books.

Next, calculate your existing liquid assets that can be used to pay bills, like savings, current postgraduate funds, and your spouse’s income. Subtract this total from your current financial obligations. The remaining number is the life insurance amount you’ll need.

Purchasing a life insurance policy provides financial protection for the people who depend on you. If you pass away, your family will receive a lump sum of tax-free money to use toward housing, transportation, and other everyday expenses.

Determining the proper amount of life insurance coverage depends on your overall financial plan, age, health, and policy’s affordability. At the end of the day, your life insurance policy should be affordable while still meeting your family’s needs.

We're grateful to our friends at PolicyMe for lending their life insurance expertise to the LowestRates.ca audience. PolicyMe is a Toronto-based life insurance solution that's made it easier to get a quote online, apply for coverage, and get approved for a fully underwritten policy in minutes, not weeks.