Rules of thumb for coverage amounts tested against three households

"Ten times your salary." "Whatever your employer gives you." "Just enough to pay off the house." Rules like these spread because they are easy to remember, and each one is right for somebody. The trouble is that nobody can tell from the rule itself whether they are that somebody.

This post tests five common shortcuts against three invented households. The households differ in age, debts, assets and dependents, so each rule has a chance to look good and a chance to fail. All figures are hypothetical and rounded, and they leave out taxes and Social Security survivor benefits to keep the arithmetic readable. They are not typical of any real family.

The three households

Each household gets a "careful need", calculated the way our guide to How much life insurance do I need? describes: years of income to replace, plus debts, plus goals, minus the savings the family would actually spend. We call the result the gross need, meaning before counting any life insurance already in force.

Household 1: Rosa, 29, single. Rosa earns $60,000, rents and has no children. She owes $25,000 in private student loans that her mother co-signed. She has $5,000 in savings and a group policy through work worth one times her salary, $60,000.

• Debts to clear: $25,000
• Final expenses (an assumed $10,000): $10,000
• Income to replace: none, since nobody depends on her pay
• Minus savings: $5,000
• Gross need: $25,000 + $10,000 - $5,000 = $30,000

Household 2: Dev, 38, married with two children. Dev earns $80,000. His spouse Anita earns $30,000 part-time. The children are 4 and 7. The mortgage is $320,000, savings total $40,000, and Dev's employer provides group life of one times salary, $80,000. The household would miss about $45,000 a year of Dev's contribution until the younger child is 18, which is 14 years.

• Income to replace: $45,000 x 14 = $630,000
• Mortgage: $320,000
• Education (assumed $40,000 per child, two children): $80,000
• Final expenses: $10,000
• Minus savings: $40,000
• Gross need: $630,000 + $320,000 + $80,000 + $10,000 - $40,000 = $1,000,000

Household 3: Tom, 52, married, children grown. Tom earns $120,000 and his wife Linda earns $90,000. The mortgage has $60,000 left. They hold $150,000 in ordinary savings, which they would spend, and larger retirement accounts that Linda would need for her own retirement and are left out. Tom's group coverage is $120,000. If Tom died, Linda would need to replace about $20,000 a year for the 8 years until her own retirement.

• Income to replace: $20,000 x 8 = $160,000
• Mortgage: $60,000
• Final expenses: $10,000
• Minus savings: $150,000
• Gross need: $160,000 + $60,000 + $10,000 - $150,000 = $80,000

Gross need is the number any rule is trying to hit. Existing group coverage counts toward it, so Rosa's $60,000 at work already exceeds her need and Tom's $120,000 more than covers his. Dev's $80,000 covers a fraction of his.

Rule 1: "Ten times your income"

The rule says to buy a death benefit equal to ten years of gross pay. Our guide on income replacement: the 10x rule and better ways explains where it comes from and why it is a start rather than a finish. The rule has a strength: it scales with earnings and it is hard to forget.

Applied to the households:

What happened. The rule treats income as the driver. But a single person without dependents has a need driven by debt, and a person with a long horizon has a need driven by years, not pay. Rosa would pay for a large policy she does not need, and Tom would pay for a policy 15 times larger than his need. Dev's family is actually the one the rule is meant for, and it still undershoots, because the mortgage and school costs are large compared with his salary.

Fair verdict. The shortcut works best for a mid-career parent with a mortgage and a typical horizon. It fails at both ends of life. Used as a sanity check on a careful calculation it is useful; used as the answer it is wrong for two of the three households here.

Rule 2: "Whatever my employer provides"

Many employers provide group life insurance equal to one or two times salary at no cost. The shortcut says the benefit is enough. The costs are zero and the enrollment is automatic.

What happened. The rule is excellent for Rosa and Tom. It is dangerous for Dev, whose employer coverage meets under a tenth of his need. The rule also hides a timing risk that the table cannot show: group coverage typically ends when the job does, and the conversion or portability options carry short deadlines. Our guide on is life insurance through work enough? describes the gaps.

Fair verdict. For a single person or an older couple with assets, work coverage may be all they ever need. For a family with young children, it is a base layer. Rule 2 passes when the gross need is small and fails when it is not, and the rule gives no way to tell which case you are in.

Rule 3: "Cover the mortgage"

Cover the biggest debt and the family can stay in the house. It is a concrete goal, and it fits a real worry. A housing payment is the cost most households cannot cut in a hurry.

What happened. The mortgage is a necessary part of the calculation, not the whole calculation. A surviving parent can own the house outright and still have no income to feed the children. Dev's family would be debt-free and short of $680,000 for the years of lost pay and school.

Fair verdict. Rule 3 is a floor, not a target. It is a sensible minimum for a household that has other resources, and in that case it works. Our guide on mortgage protection insurance vs term life compares dedicated mortgage products with ordinary term coverage if the house is the main concern.

Rule 4: "One million dollars"

A flat round number is easy to explain and easy to quote. The reasoning is that a million dollars invested for a family, drawn down gradually, produces an income for a long time.

What happened. The rule lands exactly on Dev's need, and that is coincidence. We built Dev's household to demonstrate a pattern, not to flatter the rule: change his income to $90,000 or his mortgage to $280,000 and the match disappears. Meanwhile Rosa and Tom would be paying for coverage 12 to 33 times their need.

Fair verdict. A flat number ignores everything about the household. It tends to be right when it happens to match a young family with a mortgage, and wrong otherwise.

Rule 5: "Buy as much as I can afford"

The last shortcut starts from the budget, not the need. A person decides on a monthly figure and buys whatever it covers. The budget is real and a reasonable constraint. A policy that lapses because the premium was too high protects nobody, which is why this rule is popular with people who have been burned before.

This rule cannot be tested with a table, because it returns a different number depending on price. What can be said is how it behaves:

• For a household where the need is large (Dev), the budget may not reach the need. The honest outcome is then a decision about trade-offs: a shorter term, a smaller amount, a laddered set of policies, or a plan to revisit in a year or two. Our companion post a fixed monthly budget: what it buys in term, whole and universal life works through what one budget buys in different products.
• For a household where the need is small (Rosa, Tom), the budget will usually exceed the cost of the need. Spending all of it buys coverage nobody uses.
• The rule has no memory of the goal. If premiums are cheap, the buyer ends up with more coverage than needed. If they are not, the buyer ends up with less.

Fair verdict. The rule is useful as a constraint on a careful calculation and weak as a method. Use the calculation to find the target and the budget to choose between ways of reaching it.

What Dev does after the rules fail him

Dev is the only household whose result matters, because he is the only one with a real shortfall. Here is how the careful number turns into a plan, still with invented figures.

Dev's gross need is $1,000,000 and his employer provides $80,000, so the gap to buy is $1,000,000 - $80,000 = $920,000. One policy of that size for 14 years is a reasonable answer. There is also a way to match coverage to a need that shrinks.

Imagine Dev rerunning the calculation ten years from now. The younger child is 14, so only 4 years of income remain to be replaced: $45,000 x 4 = $180,000. Suppose the mortgage has fallen to $250,000, school costs are still $80,000, and final expenses are still $10,000. Savings have grown to $90,000. The need is $180,000 + $250,000 + $80,000 + $10,000 - $90,000 = $430,000, and after the $80,000 of work coverage, about $350,000 is left to insure.

That suggests two layers rather than one: $350,000 of coverage lasting 20 years, which covers the long tail, plus $570,000 lasting 10 years for the heavier early years. Check: $350,000 + $570,000 = $920,000, the gap at the start. Because the 10-year layer ends when the need has fallen, Dev pays less in total than for a single $920,000 policy held for 14 or 20 years. Our guide on laddering term life policies to match your needs explains the structure, and the trade-off is that two applications mean two sets of fees and possibly different underwriting outcomes.

No rule of thumb suggested this, because none of them has a time dimension. That is the biggest weakness they share.

How sensitive the answer is

The careful calculation is not exact either, and it is worth seeing how much each input moves it. Take Dev again and change one thing at a time.

• Years of income. If Anita can work full time after two years instead of 14, the income line falls from $630,000 to $90,000, and the gross need drops from $1,000,000 to $460,000. The assumption matters more than the pay.
• Mortgage. A refinance that adds $40,000 of cash-out debt adds $40,000 to the need, dollar for dollar.
• Education. Moving from $40,000 per child to $80,000 per child adds $80,000. Moving to zero, if the children are expected to fund their own school, removes $80,000.
• Savings. Every dollar of savings you would truly spend reduces the need by a dollar. Retirement accounts are the common judgment call.

The pattern is useful. The inputs that move the answer most are the number of years and the mortgage, and those are also the two that change with the passage of time. This is why checking the sums again at each life event, as in when to recalculate your coverage amount, event by event, does more good than polishing the first estimate.

Scorecard

Counting exact hits is not the point, but the table makes the pattern plain.

No rule is right for all three, and no household is served by the same rule as another. This is why the shortcut people trust most is the one that happens to resemble their own situation.

What a rule of thumb is good for

None of this means shortcuts are useless. They have three honest jobs:

1. A sanity check. After a careful calculation, compare the result with ten times income. If the two differ by a factor of five, look for a mistake or a good reason.
2. A starting point for shopping. Quotes at a round amount, such as $500,000 or $1,000,000, are cheap to compare. You can refine the amount once you know the price.
3. A guard against the worst error. A rule makes it harder to buy $25,000 when you need $1,000,000.

What they cannot do is carry the decision. The lighter alternatives are the The DIME method for sizing life insurance, which is quick and covers debt, income, mortgage and education, and the human life value calculator, which values lifetime earnings and is useful for people with a long horizon. Our How much life insurance do I need? lets you run the arithmetic with your own inputs. For a worked example of the DIME method on a family of four, see Walking through the DIME method for a family of four, step by step.

Two adjustments no rule makes

The length of the horizon. The same $1,000,000 lasts a long time if it is drawn at a slow pace and a short time if a family needs $80,000 a year. The more years you need to cover, the more face amount you need, and the more it makes sense to choose a level term insurance policy long enough to cover them, so that the death benefit is there for the whole period.

Inflation. A fixed face amount buys less each year. A household that needs $45,000 a year today will need more in 14 years. See inflation and life insurance: is your coverage shrinking for how much margin is sensible. A modest margin is cheap compared with the alternative.

When a shortcut is still the right call

A rule can be the right answer when the facts are unusual in a convenient direction. A young adult with no dependents and a debt or two does not need a careful model; the debt plus final expenses is the answer. A retired couple with ample assets does not need income replacement. A family of five on one salary needs the full calculation, because the result is large and the error is costly.

If you are unsure which category you are in, run the calculation once and compare. It takes an hour. If the careful number and the shortcut agree, you have learned the shortcut works for you. If they do not, you have learned something more valuable.

Key takeaways

• Every shortcut works for some households and fails for others. The failure is invisible if you only use the rule.
• Ten times income overshoots at both ends of life, for single people and for older couples with assets, and may fall short for a young family with a large mortgage and school costs.
• Employer coverage is enough for people with small needs and a fraction of what a young family needs. It typically ends with the job.
• Covering the mortgage alone is a floor. It leaves out years of lost income and school costs.
• Use rules as a sanity check on a calculation, not as the calculation. Run the numbers once with your own debts, assets and years of support.