How can the correct amount of life insurance to purchase be estimated?

To determine the appropriate amount of life insurance to purchase, one common method is to consider the coverage needed to replace lost income for dependents in the event of premature death. A widely used rule of thumb is to divide your annual gross income by a percentage that reflects your family's needs and future expenses.

Dividing annual gross income by 5 percent provides a straightforward formula to estimate how much life insurance is needed. This approach recognizes that the insurance payout should ideally replace a significant portion of income over a longer period, thereby ensuring that dependents can maintain their lifestyle and cover necessary expenses such as housing, education, and daily living costs.

Typically, the resulting figure offers a multiplier of income that can provide a substantial financial cushion for survivors. This sensitivity to a higher percentage illustrates the need for adequate coverage, as life insurance is primarily intended to support individuals who depend on the policyholder's income. Methods that suggest dividing income by lower percentages may not account for the true financial impact of losing a primary income source over time.