You can’t pinpoint the ideal amount of life insurance you should buy down to the penny.  But you make a sound estimate if you consider your current financial situation and imagine what your loved ones will need in the coming years.

In general, you should find your ideal life insurance policy amount by calculating your long-term financial obligations and then subtracting your assets.  The remainder is the gap that life insurance will have to fill.  But it can be difficult to know what to include in your calculations, so there are several widely circulated rules of thumb meant to help you decide the right coverage amount.  Here are a few of them:

Rule of thumb No. 1:  Multiply your income by 10

It’s not a bad rule, but based on the economy today, it’s outdated.  The “10 times income” rule doesn’t take a detailed look at your family’s needs, nor does it take into account your savings or existing life insurance policies.  And it doesn’t provide a coverage amount for stay-at-home parents.

Both parents should be insured.  That’s because the value provided by the stay-at-home parent needs to be replaced if he or she dies.  At bare minimum, the remaining parent would have to pay someone to provide the services, such as child care, that the stay-at-home parent provided for free.

Rule of thumb No. 2:  Buy 10 times your income, plus $100,000 per child for college expenses

Education expenses are an important component of your life insurance calculation if you have kids.  This formula adds another layer to the “10 times income” rule, but it still doesn’t take a deep look at all of your family’s needs, assets or any life insurance coverage already in place.

Rule of thumb No. 3:  The DIME formula

This formula encourages you to take a more detailed look at your finances than the other two.  DIME stand for debt, income, mortgage and education, four areas that you should consider when calculating your life insurance needs.

Debt and final expenses:  Add up your debts, other than your mortgage, plus an estimate of your funeral expenses

Income:  Decide for how many years your family would need support, and multiply your annual income by that number.  The multiplier might be the number of years before your youngest child graduates from high school.

Mortgage:  Calculate the amount you need to pay off your mortgage.

Education:  Estimate the cost of sending your kids to college.

This formula is more comprehensive, but it doesn’t account for the life insurance coverage and savings you already have, and it doesn’t consider the unpaid contributions a stay-at-home parent makes.

How to find your best number

 Follow this general philosophy to find your own target coverage amount:  financial obligations minus liquid assets.

  1. Calculate obligations: Add your annual salary (times the number of years that you want to replace income) + your mortgage balance + your other debts + future needs such as college and funeral costs.  If you’re a stay-at-home parent, include the cost to replace the services that you provide, such as child care.
  2. From that, subtract liquid assets such as: savings + existing college funds + current life insurance.

Tips to keep in mind

Rather than planning life insurance in isolation, consider the purchase as part of an overall financial plan.  That plan should take into account future expenses, such as college costs, and the future growth of your income or assets.

Talk the numbers through with your spouse.  How much money does your spouse think the family would need to carry on without you?  Do your estimates make sense to him or her?  For example, would your family need to replace your full income, or just a portion?

Consider buying multiple, smaller life insurance policies, instead of one larger policy, to vary your coverage as your needs ebb and flow.  For instance, you could buy a 30-year term policy to cover your spouse until your retirement and a 20-year term policy to cover your children until they graduate from college.  Parents of young children should consider 30-year versus 20-year terms to give them plenty of time to build up assets.  With a longer term, you’re less likely to get caught short and have to shop for coverage again when you’re older and rates are higher.