How much life insurance do you need?

Quickly calculate how much life insurance you need

How much life insurance you need depends largely on your financial circumstances but also, in part, on your own view of what is adequate. Also there are a number of different types of life insurance policies to suit specific needs, be it a requirement for a lump sum payment on death or a regular income stream. In this article I will help you work out how much life insurance you need, what it will cost, where is best to buy it and how to get up to £100 cashback.

There can be a number of reasons why people require life assurance but generally most of these fall into one of the following categories:

• To clear a mortgage, or other debts or pay funeral expenses
• To pay a potential Inheritance Tax (IHT) bill payable on your estate, so ensuring that your dependents receive more of your assets
• To provide an income or capital sum for your dependents in the event of your death

So I’m only going to look at the above scenarios while assuming that in each instance the need is to be met by the receipt of a tax-free lump sum. That means I’m going to consider ‘term assurance protection contracts’ here, which pay out a tax-free lump sum in the event of death, within a given period of time – called the term. Term assurance contracts are used to cover most people’s post-death requirements. (term assurance contracts do not have an investment element to them as they are pure protection contracts).

So going back to the original question – how much life insurance do you need? Well, a good starting point is to look at the financial requirements immediately after you die. So let’s crunch some numbers. 

Life insurance calculator

STEP 1 - Mortgage

Write down the amount of your mortgage that is outstanding. I’ll use the figure of £250,000 as an example.

STEP 2 – Other debts

Write down any additional debts you may have.

I’ll assume the figure of £20,000

STEP 3 – Inheritance tax bill (IHT)

Now calculate your rough inheritance tax (IHT) bill in the event of your death. If you are young and have a relatively modest estate (i.e. the total sum of your assets) you can skip this step.

Take the value of your worldly assets which you plan to pass on. Now deduct any IHT exemptions (i.e. you don’t pay any IHT on money left to a spouse) and your IHT allowance of £325,000 (for the tax year 2022/23).

Take 40% of this figure and you have a rough estimate of the likely IHT bill upon your death

So let’s assume you have an estate of £1,000,000 (ignoring your house which is jointly owned with your spouse – as they will assume full ownership) and you are leaving half of the estate to your spouse and half to a friend.

Then £1,000,000 - £500,000 (left to your spouse) - £325,000 (your unused IHT allowance) = £175,000 is liable to IHT. Now take 40% of this figure which gives you £70,000.

To find out more about inheritance tax, read our article 'Inheritance tax explained'.

STEP 4 – Dependents’ income shortfall

Now you need to work out the income requirements of your dependents – over and above their own earnings plus any income their inheritance will provide. I’ll assume your spouse will need an additional £50,000 a year tax-free (ignoring inflation) for 10 years after you die.

I'm going to use the cumulative lump sum of £500,000 for this example but you can buy life insurance that is designed to pay an income and can cost less. You can read more about it in our article, "What is family income benefit life insurance and should I get it?"

So we'll use the lump sum of £500,000 when you die.

STEP 5  - Existing policies

Note down details of any life insurance policies you already have, including those offered by your employer if applicable.

I’ll assume a death-in-service sum assured of £200,000

Solution

Now carry out the following calculation.

Step 1 + Step 2 + Step 3 + Step 4 – Step 5.

In my example that equals £250,000 + £20,000 +£70,000 + £500,000 - £200,000 = £640,000.

So this is the figure that you would need to insure in order to meet all of the above requirements if you were to die today. So you would be underinsured by this amount.

The most important step of all

If you've worked out that you are underinsured the most important thing to do for your family's sake is to take action. But most people don't realise how cheap life insurance is. For example, a healthy 30-year-old man could get £100,000 for around £5 a month!

After researching the market, the best way to place to buy life insurance is through our recommended life insurance specialist*. I've personally vetted their service, having used them to buy life insurance to protect my own family and I am confident that their knowledge and expertise will help you choose the best life insurance policy and level of cover for you. They are fully independent, which means that they compare life insurance policies from every major insurance company and if you take out a policy with them you will qualify for up to £100 cashback. So if you are underinsured then find out how little it costs to put it right - it will only take a few minutes.