How much life insurance do you need?

Man and woman sit in park with young daughter considering their life insurance policies.

After you’ve worked out whether or not you need life insurance, the next step is working out what level of cover you should opt for, and the key here is balance.

You don’t want to be underinsured, or your family might be left in the lurch and struggling to pay bills without your income to help. But you also don’t want to be paying super high premiums for a level of cover you don’t really need.

Here’s a “rule of thumb” method for working out approximately how much life insurance coverage you need so that your life insurance payout can effectively replace your income if you pass away. You’ll need to ask yourself:

1. How much do you spend?

If you’ve already got a monthly budget hammered out, this bit should be easy. If not, head over to our budget calculator, get out your bank statement, and work out how much your family spends in a regular month.

Consider all your monthly costs, from groceries to power bills, school fees to phone plans. For families with two incomes, you’ll usually have a single budget based on you and your partner's income - don’t worry, we’ll sort this out later.

Monthly spending: $1,500

2. How much debt do you have?

Next, consider any debt you’re working to pay off. Something like a mortgage is pretty easy to account for, since it’s a set monthly repayment for a certain number of years. Other debts like credit cards are harder, because they can rise and fall as you spend, and it’s not as easy to know how long they’ll stick around.

Plan for your monthly mortgage repayment, and, if you tend to carry other debt you might want to add onto your estimate to cover this possibility as well.

Monthly debt repayments: $4,000

3. How much do you save?

The other thing to consider is your family savings plan. There are two sides to this: on the one hand, the more you’ve got saved up, the less your family will be relying on your insurance payout to make ends meet. That means you can opt for a lower level of coverage and pay lower premiums.

On the other hand, if there are savings goals you’re working toward, you may want to factor that into your life insurance payout. For example, you may be saving to send your kids to uni, or to travel in retirement. You could add a small amount to your monthly costs estimate as a contribution to this rainy day fund.

Monthly savings: $500

4. What does your monthly salary cover?

So, let’s say your total monthly outgoings, including living expenses, loan repayments and a small savings plan add up to $6,000. The next step is to work out how much of this bill is covered by your paycheck, and how much is covered by your partner or other investments you’ve made.

For this example, we’ll say it’s split right down the middle, and your salary covers $3,000 of expenses each month, or $36,000 each year.

Annual expenses: $36,000

5. When will you retire?

Your life insurance policy only really needs to cover costs for as long as your salary might have – by retirement age, your kids will likely be grown up and supporting themselves, and your spouse should (hopefully) have a retirement plan in place.

So a good rule of thumb is to plan until the age of 65. If you buy your policy at, say, 35 and plan to retire at 65, you’ll need $36,000 each year for 30 years. That’s a lump sum payout of $1.26 million.

Annual expenses x 30 years = $1,260,000

Another way to think about it is to consider what your family will do with the lump sum payment they receive. A good investment strategy can mean a smaller lump sum will still cover their expenses for many years.

For example, if we say your family could invest your payout and earn a 2.00% return each year, then all you need to do is divide your $36,000 annual expenses or 'salary' by 2.00%.

Annual expenses ÷ 2.00% = $450,000 

That means your family would need $450,000 in savings, invested for a return of 2.00%, in order to “earn” $36,000 each year and replace your salary.

So as a ballpark figure, you could opt for life insurance coverage amount between $450,000 and about $1.3 million.

Will this method work for me?

This is a pretty basic method to help you work out what level of life insurance cover might be appropriate for you. But keep in mind, your circumstances are always unique and it may not be right for everyone. For example, if you have a lot of savings, don’t have kids or if you’re closer to retirement age, you’ll likely want to consider a lower level of cover.

So use this method as a guide, but if you’re not sure how much life insurance would be appropriate for you, it may be worth getting some professional financial advice before going ahead.

When to buy life insurance

Another thing you might be wondering is when you’ll need to buy a life insurance policy.

You can generally buy a policy up until you’re about 65 years old, and renew it up until you’re 99. But remember: life insurance premiums get more expensive as you get older, so thinking about life insurance early on can be a good way to save.

The maximum benefit you can claim may also depend on your age. As you get older, your policy will pay a smaller amount.

Choosing a life insurance term

Life insurance in Australia is generally what’s called ‘term life insurance’. That means, it covers you for a predetermined amount of time.

You’ll need to nominate the term when you buy your policy, which is why most people have life insurance to cover them until retirement age, at around 65.

Where to find a life insurance policy

Once you’ve worked out how much life insurance you need, the next step is finding a killer deal so you can score a policy without breaking the bank. Head over to our life insurance page to compare some of the best offers in the market today or check out the options below.

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