When buying life insurance, consumers must make a crucial choice during the process of acquiring their policy. They must decide how large to make their death benefit.
Policies with a larger death benefit have higher premiums, so it’s best not to make the death benefit larger than necessary. But if the policyholder dies, a larger amount of money will be paid to beneficiaries if the death benefit is bigger. So the trick is to make sure the death benefit amount provides enough protection, but not too much.
There are many approaches to deciding on the right amount of life insurance coverage. One easy shortcut involves multiplying income by 10 and buying a policy for that amount. But there’s actually a simple formula that can be really effective at getting the right size death benefit. Here’s what it is.
Consider the DIME approach when buying life insurance
When buying life insurance, the DIME formula can make determining the appropriate death benefit easier. DIME stands for:
When following this formula, this means the death benefit should be large enough to cover:
- The total outstanding balance of any debt that has been accrued by the policyholder
- The total amount of the policyholder’s income that must be replacedbased on how much they were earning and how many years their income will be relied upon by surviving dependents
- The total outstanding balance of any mortgage loans on property the policyholder owns
- The total estimated cost of educating any children the policyholder has
It’s typically easy to get accurate numbers for these items. As a result, using this formula can help consumers who are purchasing life insurance to determine exactly how much is needed to cover their remaining coverage obligations if they pass — and to provide for the people they are leaving behind.
Why this formula can be a great way to get the right amount of coverage
The DIME formula can be a much better way of figuring out how much life insurance coverage is appropriate compared with shortcuts such as multiplying income by a set number.
The simple reason the DIME formula is such a good approach is because it takes each person’s unique situation into account. Someone with more children, for example, would likely need a larger life insurance policy than someone with no children because kids can be expensive to educate.
Likewise, a person with a large mortgage loan would need to make sure there is money to pay off that loan to allow the house to stay in the family, while someone without a mortgage may not need so much coverage. A method that just multiplies income won’t take these factors into account.
The reality is that the purpose of buying life insurance is to provide for the unique needs of survivors who are left behind. And making sure that loved ones can keep their house, cover debts, and get an education are the key components of providing for people who must cope with the untimely death of a family member.
It’s worth making the effort to do this calculation and take a personalized approach to deciding on a life insurance death benefit, because once a death has happened, it’s too late to go back and get more coverage.
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