One of the most thorough ways to calculate the amount of life insurance you need is the DIME method, which looks at your debt, income, mortgage and education needs to provide a comprehensive estimate of your necessary life insurance coverage level. To use the DIME method:
- Start by adding up all your debts, excluding your mortgage. Add in the estimated cost of a funeral and burial expenses.
- Determine the number of years your family needs to rely on your income replacement and multiply your annual income by that number.
- Add in the payoff figure for the mortgage and the estimated cost of sending any children to college.
- Subtract the value of additional life insurance policies. This number is the minimum amount of coverage you need to purchase.
To illustrate how this works, consider the following two scenarios. The first calculates the life insurance needs for a single mother of two, while the second scenario calculates the needs for a single, young professional.
The future policyholder owes $12,000 in credit card debt, $8,000 on her car loan and $9,500 in student loan debt, which gives her a total debt of $29,500. She makes $100,000 per year and wants to provide income replacement until her youngest child graduates high school, which is in 14 years, bringing her to a total income replacement of $1,400,000. She owes $250,000 on her mortgage and wants to set aside $100,000 for each of her children’s college expenses.
Her total according to the DIME method equals $1,879,500. She has $1.4 million in term life through work and she opts for $479,500 in whole life.
The future policyholder owes $8,500 in credit card debt, $20,000 in student loans and $10,000 on his car. He makes $40,000 at his entry-level job, but has no dependents to care for. Instead, he wants to provide for his aging parents with at least 10 years of his income, or $400,000. He rents and has no children, which eliminates the mortgage and education components of the calculation. According to his DIME calculation, he needs a policy with at least $438,500 in benefits. He has no other life insurance, so he applies for the full amount of $439,000 in a whole life policy.