In my last few blogs about life insurance, we’ve covered why young physicians to get life insurance and what type of insurance of life insurance is best for young physicians. Now, the next question to address is how much life insurance a young physician should get. This question is more difficult to answer because it varies greatly depending on your family situation, income, lifestyle, and more. There are various methods to calculate how much coverage you need, each with its own considerations. Let’s explore four common methods to determine the right amount of life insurance to safeguard your loved one’s financial well-being.
10x Your Income
The first method is very straightforward – simply take your income and multiply it by 10. Why does this calculation use 10 times? There are a couple of reasons. First, it will provide your family with enough cushion to continue operating in the short term, should anything happen to you. Second, the payout can be invested and continue to grow to replace your income.
For example, let’s say Dr. Cook is a hospitalist from Nebraska, married, has one child, and her income is $265,000. Using this method, she should buy $2,650,000 (10 X 265,000) in term life insurance.
This quick calculation gives you a great starting point; however, you shouldn’t base your entire decision on this method. Because it is the simplest method, it doesn’t consider anything other than your income. Other methods take into account personal details like current savings and investments, future goals, and debts.
10x Your Income Plus Extra for College
The second method builds on the first – simply take your income and multiply it 10x. Then, add $100,000 per child to fund college. If paying for your child’s college expenses is an important part of your financial plan, then using this method might make more sense than the first. Paying for college is expensive, so taking care of that goal with life insurance proceeds and not leaving your family burdened with that extra expense is a major consideration.
Following our example from above, let’s say Dr. Cook has a 5-year-old son and wants to pay for his college expenses if something happens to her. Using this method, she should purchase $2,750,000 in life insurance ($2,650,000 + $100,000).
However, just like before, this method is a little short-sighted as it doesn’t consider your current savings, investments, debts, or other future goals.
Replace Your Income + Cushion
The third method calculates how much life insurance is required to replace your income with only investment growth on the proceeds your family receives from your life insurance payout. To calculate the amount of life insurance needed under this method, divide your gross income by a conservative rate of return – I’ll use 4% as an example.
Referring back to Dr. Cook, to be able to calculate her life insurance needs using this method, you would divide $265,000 by 4% to get $6,625,000.
The idea is, if Dr. Cook had a $6,625,000 portfolio, which earned 4% a year, it would pay out $265,000/year before taxes. This would allow her husband and son to maintain their standard of living with just the investment returns alone. After her husband and son no longer needed the replacement income to meet their living expenses, the remaining balance can be used to fund other goals such as college expenses and retirement.
As you can see, using this method can result in purchasing significantly more life insurance. While your family’s needs will certainly be covered, you must consider whether it’s too much life insurance.
Although Dr. Cook’s salary is $265,000, her take-home income is lower than that – probably closer to $215,000. Dr. Cook and her family don’t spend everything she earns, which isn’t factored into the method above.
DIME Method
The final method is called the DIME method. This is a more specific calculation that takes into consideration a few personal finance details. DIME stands for:
Debt – Debt includes all outstanding debt except your mortgage. This might include student loans, car loans, home equity loans, etc.
Income – Multiply your annual income by the number of years you’d like to replace it for.
Mortgage – Calculate the amount needed to pay off your mortgage.
Education – Estimate the cost of sending your children to college.
Here’s what the DIME method looks like in action. Dr. Cook and her husband bought a house two years ago and have $550,000 left on their mortgage. Other than Dr. Cook’s student loans ($230,000), they don’t have any other debt. It’s important to them to be able to pay for their son’s college education (who’s currently 5 years old), so they included that cost in their calculations as well. Using the DIME method, Dr. Cook should get roughly $4,325,000 in life insurance.
D – $230,000 in student loans
I – $265k x 13 years until her son is in college = $3,445,000
M – $550,000 remaining on their mortgage
E – $100,000 approximate four-year cost of the University of Nebraska Lincoln in 13 years
= $4,325,000 in life insurance
You can take the DIME method a step further by subtracting any investments, savings, or other life insurance to get a more precise number. If Dr. Cook has $150,000 in her 401k, $200,000 in a joint investment account and 1x her salary in group life insurance, the actual amount of life insurance she could consider is $3,710,000.
What about stay-at-home parents?
Even stay-at-home parents should have some amount of life insurance coverage. There are a lot of duties that a stay-at-home parent takes care of that would cost money if they weren’t there. Costs like childcare, housekeeping, food-making, grocery shopping, and more need to be considered. Add up these costs and multiply them by the number of years until your kids are out of the house to figure out how much life insurance a stay-at-home parent might need.
Custom solution is best
While these methods offer valuable insights into estimating your life insurance needs, they are not perfect solutions. Personal circumstances, financial goals, and future plans all need to be considered when deciding on what amount of coverage you need. At Panoramic, we help calculate your exact needs so that all your expenses are covered without paying for extra insurance you don’t need. We also go beyond the numbers and have conversations about the emotional side of life insurance as well.
Remember, the goal is not just to provide for your family’s immediate needs but also to empower them to thrive in the long run, even in your absence. So, whether you’re aiming to replace your income, secure your child’s education, or clear debts, a thoughtful approach to life insurance ensures peace of mind for you and financial security for your loved ones.
Panoramic Financial helps new attending physicians make sure that they have proper life insurance coverage in place. Please click “Work With Us” at the top of the page to learn more.
The foregoing content reflects the opinions of Panoramic Financial and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Panoramic Financial does not give tax or legal advice. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.