The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.
Rule #15: You need enough life insurance to replace at least five years of your salary–as much as 10 years if you have several young children or significant debts.
I agree with the spirit of this rule: most people don’t leave behind nearly enough life insurance to ensure the continued success of their family after a tragedy. To me, not having adequate life insurance is a classless act – you’re making a potential tragedy worse by being greedy now.
I also agree with the sentiment about leaving behind more life insurance if you have children, but this is where the rule gets quite vague. What does “if you have several young children” actually mean? It’s a very vague statement that makes me sit back, stroke my chin, and whip out my trusty pencil.
First of all, life insurance should cover your funeral and estate management right off the top. To ensure that everything is taken care of, you should have a minimum of a year’s salary put away. Even if you live entirely alone, this should exist to eliminate any burden you might put on other family members in the event of your passing.
Life insurance becomes important as soon as you begin to build your own family. If your income is even slightly responsible for the well being of anyone else, you need to put away two more year’s worth of salary in insurance to cover the hardships that would overcome them simply recovering from your loss. Beyond that, you want each person dependent on you to be able to continue to live something approximating the life they’re accustomed to, so you should have two years’ worth of insurance for each other dependent as well.
These suggestions add up to a very nifty formula for figuring how much life insurance you should have. Take the number of dependents in your household, double it, and add one. Multiply that number by your annual salary and that’s the approximate number you should be looking at. Let’s rewrite this rule.
Rewritten Rule #15: You should leave behind a year’s worth of life insurance to cover your funeral, plus two years’ salary for each dependent you claimed on your last tax return (including yourself).