How Much Insurance do you Need?

Having the right type and amount of coverage is central to protecting your family's financial well-being.

our income and the savings you've built over the years make up the backbone of your financial strategy. It's essential to protect what you have against risks related to injury, lawsuits, or death. This means having insurance policies—for life, disability, and liability—that can replace your income and safeguard your assets. "You might think you won't be that person who suffers a catastrophic loss," says Christine Fahlund, CFP®, a senior financial planner with T. Rowe Price. "But you can't afford not to protect your assets."

Fifty-four percent of parents said they don't have life insurance, according to T. Rowe Price's 2013 Parents, Kids & Money Survey. If your death would create financial hardship for your loved ones, it's essential to own a policy with enough coverage to take care of them.

Start by determining how much life insurance you and your spouse need. The amount of coverage that's best for your situation depends on your age, your dependents, and the financial resources available to you. (See "Calculating Your Life Insurance Needs." ) Consider these factors:

  • Income. Your after-tax income and your spouse's after-tax income
  • Benefits. Cost of any employer benefits the surviving spouse would need to replace
  • Children. Your dependent children's financial needs, including college

If you or your spouse is the caregiver for your children, estimate how much it would cost to pay providers to help run your household. "There are a lot of ways in which a couple supports each other," Fahlund says, "and you want to put a dollar figure on them."

You'll need a variety of insurance to protect yourself against different events.

Covering your family with life insurance. In addition to determining the amount of life insurance you need, you will have to choose between purchasing a whole life or a term life policy—and designate your beneficiaries. "In general," notes Fahlund, "term life is significantly less expensive than whole life and is the better option for most individuals."

Protecting your income with disability insurance. If you became ill or injured and couldn't work, could you pay your mortgage and household expenses? Research by the Council for Disability Awareness found that 65% of Americans wouldn't be able to cover their living expenses for a year without employment income, and some 38% wouldn't be able to support their families after just three months.1 Disability income insurance can replace lost income while you recuperate.

Disability insurance is especially important if you're self-employed or single. Without insurance, a long-term illness or injury could eliminate your income for months or even years. Social Security offers disability benefits, but they're not easy to obtain and they may not meet your cash flow needs. "If I'm married and I become disabled, my spouse can go back to work or work longer to help support me," Fahlund says. "But if I'm single, I may be really on my own."

You may already have disability coverage through your employer. But many employer policies provide only short-term coverage, which pays a percentage of your income for up to one year. Consider purchasing a long-term disability insurance policy, which typically begins after a three-month waiting period and lasts until your retirement date. These policies generally replace 50% to 70% of your income. Disability payouts are tax-free if you pay the premiums with after-tax dollars. If you pay them with pretax dollars—which many employers allow their employees to do—the benefit is taxable, even though you're the one paying the premiums. Unfortunately, disability insurance premiums tend to be high—especially if you are not eligible to participate in an employer group plan. The coverage is worth the expense, according to Fahlund, who adds, "Everyone who is working should have it."

Guarding your assets with liability insurance. An "umbrella" liability policy picks up where your auto and home policies' liability coverage leaves off and may cover second homes, boats, trucks, and other property. Liability coverage protects you from the risk of having to pay a catastrophic amount out of your own pocket if you are sued or held liable for events such as injury to someone other than yourself or negligence. Liability policies cover both legal costs and any legal payouts. They only come into play after you've exhausted other insurance policies. Individuals often buy umbrella policies that provide $1 million or more of coverage.

Liability insurance is especially important for people who are at risk of being held responsible for injuries to others, including medical practitioners and business owners. Older individuals can be vulnerable to lawsuits, partly because they may have considerable savings. Says Fahlund, "Our exposure changes as our lives and needs change."

Calculating Your Life Insurance Needs

Take the following steps to estimate how much insurance you may need. You can always increase or decrease your coverage as your circumstances change. Increasing the dollar amount of life insurance you buy generally results in only a slight increase in premium.

A comprehensive financial plan includes strategies to grow and preserve your assets, as well as the appropriate amount of insurance coverage to protect you, your family, and your accumulated assets. Consider your circumstances and adjust your coverage as appropriate. "Make sure you're well-versed in your options," Fahlund says. "Peace of mind comes from knowing these issues are covered."

1Council for Disability Awareness.


1Your savings rate depends on your age and the current size of your nest egg.
2Christine Fahlund, CFP®, a senior financial planner with T. Rowe Price, explains what "successful" retirements have in common.
3David Giroux, portfolio manager
of the T. Rowe Price Capital Appreciation Fund (PRWCX).
4Portfolio Manager Ray Mills and his team search for companies in foreign markets that are undervalued.
5With the economy recovering, interest rates are likely to rise in the future. What does this mean for investors?
6Having the right type and amount of coverage is central to protecting your family's financial well-being.
6The new Social Security Benefits Evaluator; T. Rowe Price named in "MONEY 70®;" and more.
8In developing FuturePathSM,
T. Rowe Price combined complex modeling with real-life experiences.
9The changes in tax law have prompted many investors to consider the benefits offered by municipal bonds.
12Four action steps that can strengthen your financial position and help you reach your retirement goals.
11Compounding over time helps
generate wealth.