Eyes up Soldiers! There are only three guarantees in life: taxes, change, and death. Those are certainly not fun topics to dive into. Death in particular, must be discussed when it comes to a family’s finances. What vehicle helps us facilitate this conversation? Life Insurance. Generally speaking, it’s been said to purchase 10-12x your annual income in term life insurance for the purpose of income replacement. We’re going to get more specific and walk through a four factor model known as the DIME method to help you decide how much life insurance you need to buy.
What Does DIME mean?
Credit card and student loan debt are both north of $1 trillion in the U.S. Auto loans are on their way to surpassing the $600 monthly payment range. Statistically speaking, your family probably has some sort of outstanding debt. When deciding how much life insurance coverage to buy, add up the total amount of debt you owe. Let’s say for example you have $5,000 in credit card debt, $30,000 in student loans, and $10,000 left to pay on an auto loan. Together your total debt is $5,000+$30,000+$10,000 equaling $45,000 in total debt. Though not considered a debt, go ahead and account for burial/funeral expenses in this step as well. According to the National Funeral Directors Association (2017), the national median cost of an adult funeral with a viewing and burial is $7,360. You can use a round number like $10,000 to account for death expenses. Citing our totals, $55,000 ($45,000 debt, $10,000 funeral) is the starting point for our life insurance purchase example. Doing this will bring peace knowing you’ve got enough coverage to pay off ALL family debts and give your loved one a proper burial. Leave a legacy of financial freedom, not one of anxiety, stress, and confusion.
Perhaps the most common reason for getting life insurance is income replacement. When you lose a working loved one, you lose their monthly salary as well. If one desires for their family to maintain the same or similar standard of living upon his/her death, the formerly earned income must be taken into consideration. Remember the basic 10-12x your income adage? This is where we get more detailed. Let’s say your loved one made $3,000 per month. That’s $36,000 annually. Take that lost annual salary and multiply it by the number of years you believe your family would require financial support. For instance, let’s say you want cover lost income for the remaining years your youngest child has until they turn 18. Using a 10 year old child as an example, you would multiply $36,000 x 8 remaining years until age 18. This comes out to be $288,000 as the total income replacement need.
You’re probably wondering why a mortgage wasn’t included in the debt section. A mortgage is worthy of it’s own category in the DIME method because it’s usually the largest expense someone will ever have. Whatever is left for you to pay down on your mortgage, add this into your total insurance calculation. For our running total, we will go with $235,000 as an example because it’s also the national median purchase price of a home in the U.S. (National Profile of Home Buyers and Sellers, 2017).
It is of utmost importance to set up our children’s future. In this step of the DIME method, you focus on providing your children with a college education. Calculate the total cost of tuition and fees. At the time of this blog post (using the College Board as a reference), the average cost of tuition and fees for the 2017-2018 school year was $34,740 for private colleges, $9,970 for state residents at public colleges, and $25,620 for out of state residents attending public colleges. For our working example, let’s pretend your son or daughter is set to attend an in state public school to stay close to home. Let’s go ahead and round $9,970 to $10,000. Multiply $10,000 x 4 years of attendance. That leaves us with $40,000 for college education to add to our running total.
Let’s bring it all together with our running total example:
- Debt = $55,000
- Income = $288,000
- Mortgage = $235,000
- Education = $40,000
- Total Life Insurance Need = $618,000
Soldiers, this was an exploration of the DIME method. We now know how to calculate the proper amount of life insurance coverage needed for our situation. Time to put what we learned into action. Do you have life insurance? If you do, is it enough to properly take care of your family? If you don’t, it’s time to find a professional who can assess your needs and quote you term life insurance.