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Life Insurance: How Much Do You Need?

Most people struggle with how much life insurance to buy.

As a broad guideline, if anyone depends on you for financial support -- a spouse and children, older parents or a disabled relative -- consider buying sufficient life insurance to replace your salary and any other kinds of income, such as how much you pay for health insurance now, or employer matching funds for a 401(k) account.

Even if you're childless and your spouse or life partner is employed, you might want to buy life insurance to pay off your mortgage on your home if it takes two incomes to make the payments. You may also want to set aside funds for any changes your dependents would need to make after your death, such as moving closer to other relatives who can help care for them.

Bread winners aren't the only ones who need insurance. Hungelmann says anyone providing a benefit for the family but not earning outside income should have between $250,000 and $500,000.  And not just because it would cost a lot to hire a nanny and a housekeeper.  "If your kids lose their mother, it would be nice to be able to afford to take time off to help them cope with the loss," Hungelmann notes.

Life Insurance Types

There are two basic types of life insurance. Term insurance pays only if a death occurs during the life of the policy, typically between 1 and 30 years. The premium and the size of the payout usually remain level during this period.

Hungelmann says this is the best product for most people. Most choose a term that is long enough to cover you until your youngest child finishes colleges and they can support themself. In most cases, you won't have reached an advanced age and will remain relatively healthy before the term is up; this keeps the cost down, because fewer people collect. 

The other type is whole life insurance, also known as permanent insurance. It is much more expensive, but pays the same death benefit whenever you die –- no matter your age. In order to keep the premiums level over the life of the policy, insurance companies set the rates high enough so the money they collect in the early years offsets the increased risk when you're older.

The difference between the premium you pay in the early years and the actual cost to the insurance company of insuring you is called a "cash value." It is set aside in a savings account; your options for investing vary with the type of policy.

You may be able to borrow against the value, and if you opt not to renew your policy, you can get some of it back. In later years, when the premium you pay not longer covers the cost of insuring you, the savings is drawn down.

Hungelmann says whole life is the best option if there is someone who will always need your financial support, such as a disabled child. However, most folks should stick with term life.

"The biggest problem with permanent insurance is it's not as good a buy; young people with kids who buy permanent insurance typically have much less than they need because it is so expensive," he says. As a result, "they are way under-insured."

For example, a healthy 30-year old male will generally pay less than $1 per year for a thousand dollars of coverage with term life insurance; the same amount of whole life costs $5 to $10 per thousand dollars of coverage.

Allison Bisbey Colter is a freelance writer in New Jersey whose work has appeared in The Wall Street Journal and American Banker. She is a former editor at TheStreet.com and a former reporter for Dow Jones Newswires.

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