This post is part of an ongoing series called “Deconstructing Financial Rules Of Thumb,” where I break down generally accepted financial principles and give you my opinion if they are worth following.
Death – what a fun topic to discuss! Haha
Unfortunately, most people try their hardest to avoid this conversation. But we all know that burying your head in the sand is a great way to increase your chances of making a bad decision.
As you’re creating your financial plan, the topic of protection will eventually come up. Life insurance can be a great way to protect the financial livelihood of your family in the event of your demise.
But how much is enough?
THE 12 TIMES SALARY RULE
A popular rule of thumb for determining how much you need in life insurance is the “12 times salary” rule.
As you probably put together, you take your annual income and multiply it by 12 to get the total amount of insurance you should buy.
The clear advantage of this rule is the simplicity.
You don’t have to do much thinking or calculating to figure out how much you’ll need if you follow this rule.
Once you decide to obtain life insurance, you’ll be able to acquire it relatively quickly with this discovery process.
The problem with this rule is that there is a high probability that you could be missing a lot of nuances in your personal plan.
The more complicated your situation, the more important it is to go through a detailed analysis to figure out how much you need.
A person with multiple businesses, a large family with many children they hope to send to college, and philanthropic aspirations, will have a much higher need than a single individual who only has to worry about a loan that was co-signed by a parent.
The 12X target might be much more than the single individual needs, but fall drastically short for the first individual.
I am lukewarm on this rule.
I like it because it makes the process easy for people to get going. And in place of having nothing, I’d rather someone get the 12X amount of life insurance so their family has at least some protection in place.
Taking action is the most important thing.
The thing I don’t like is its simplicity. You heard that right.
The fact is everyone’s situation is unique, and everyone wants the ability to provide different things for their family
Also, at different ages, your insurance needs will change. If you are in your mid-20’s and are just starting a family, there are many years left until your children will be out on their own, and able to support themselves. The risk is much higher at this stage than when you’re in your 50’s and your kids are out of the house with their own careers.
You also have to factor in cost. But by buying term life insurance, the cost should usually be relatively affordable.
In the end, this rule is a good place to start, but it might fall very short of your actual needs. It’s better to consult a Certified Financial Planner or life insurance specialist to make sure you are getting adequate protection.