Cut in Half and Drop a Zero

Take your total life insurance coverage. Cut that number in half. Then drop a zero. The result is approximately the annual income your family would have if you died and they invested the insurance proceeds at a 5% annual return.

For example: a $300,000 policy sounds like a significant amount. Cut it in half – that’s $150,000. Drop a zero – that’s $15,000. In other words, a $300,000 policy would provide your surviving family with roughly $15,000 per year in pre-tax income, or about $1,000 per month. Can your family live on $1,000 a month? If not, you need more coverage.

The formula illustrates an important point: life insurance proceeds are not typically used to pay off the mortgage in a lump sum. If your family did that with a $300,000 policy, they’d have nothing left over for food, utilities or education. Instead, the money is set aside and drawn on gradually as income. That’s why the annual income it generates – not the lump sum – is the meaningful number.

Now apply that formula to what the average American family actually has. According to the American Council of Life Insurers, the average American household carries $165,800 in life insurance. Cut that in half: $82,900. Drop a zero: $8,290. That’s roughly $690 per month. The vast majority of American families are significantly underinsured.