The DIME Formula: Calculate how much life insurance you need using this method. Image Credit: Gulf News

Dubai: In order to find out if you need life insurance in the first place, simply determine if your potential death would financially impact anybody in your life. If that’s the case, consider obtaining life insurance.

Life insurance is a contract between you and an insurance company that states that in exchange for regular premium payments made by you, the company will pay a benefit to your beneficiaries upon your death.

A life insurance policy essentially provides a measure of security for your loved ones, especially if your income was a source of support for them. Beneficiaries can use proceeds from your life insurance to cover day-to-day living expenses to paying for college to eliminating debts.

Life insurance can also compensate a family to help pay off any financial liabilities or business expenses you may leave behind.

How do I determine how much life insurance I need?

A large part of choosing how much life insurance you need is based on determining how much money your loved ones would need to remain on firm financial ground after you’re gone.

There are a number of ways to calculate how much life insurance is best for your circumstances, but there is more than one rule of thumb to keep in mind before you make your final determination.

One rule of thumb is the Human Life Value (HLV) approach, which is usually calculated by taking into account a number of factors.

This includes your age, gender, planned retirement age, occupation, annual wage, employment benefits, as well as the personal and financial information of your spouse and dependent children, if any.

How do I determine how much life insurance I need?

Another rule of thumb says you should have one or more life insurance policies with a total death benefit equal to roughly 10 times your annual salary.

This strategy doesn’t take into account your finances other than your income, existing assets or the needs of your beneficiaries; however, it’s a basic starting point.

Another way to calculate your coverage needs is to multiply your annual salary by the number of years left until retirement.

For example, if a 40-year-old man currently makes Dh20,000 a year, he will need Dh500,000 (25 years multiplied by Dh20,000) in life insurance.

The DIME Formula: Calculate how much life insurance you need using this method

Another rule of thumb is the DIME formula to determine how much coverage you need. DIME is an acronym that stands for Debt, Income, Mortgage, Education expenses.

Debts and final expenses: Add up all loan balances except mortgages, plus an estimate of your funeral expenses. All existing debt should be added up to determine how much it would cost to repay the outstanding balance due after an untimely death.

Income: Multiply your annual income by the number of years you think your dependents will need support. For example, if a spouse and children would be reliant on the policyholder's Dh50,000 annual income for 15 more years, Dh750,000 in coverage would be needed.

Mortgage: Determine how much you owe on your home, including any second mortgages or lines of credit against it. So the remaining mortgage balance should be taken into account and added to the amount of life insurance protection purchased.

Education: Estimate the cost of paying for education for any children you have. To make sure your children are educated properly, figure out how much educational costs would be and add this amount to the death benefit.

By adding all of these obligations together, you get a much more well-rounded view of your life insurance needs. You can also modify this method to include additional expenses, such as medical expenses or retirement funding.

There are also a few items that you may be able to subtract from this number, such as the amount of coverage on a group life insurance policy, funds from your retirement plan or any other savings you’ve accumulated.

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Is DIME the preferred approach to know how much life insurance I need?

Is DIME the preferred approach to know how much life insurance I need?

The DIME method can be trickier than other approaches for calculating the required amount of life insurance.

For example, a simpler technique involves simply assuming the death benefit should equal 10 times the covered person's salary, as discussed earlier. In this case, someone who made Dh50,000 would assume they require Dh500,000 in coverage.

But while the rule-of-10 has the advantage of being easy, it's also inexact and doesn't take into account each person's unique circumstances. For example, a potential policyholder may have stretched to buy a mortgage and taken out a large loan on the assumption their salary would go up over time.

This could mean surviving family members would be left struggling with a huge mortgage if the life insurance pay-out was simply based on the deceased's current salary at the time they bought coverage.

Since life insurance is an important purchase, it's worth making the effort to take specific costs into account and set a personalised death benefit based on the individual policyholder's financial situation and future goals.

This is why the DIME method can guide consumers purchasing life insurance, and is a great way to see how large a death benefit should be.

Bottom line?

Experts recommend that you get life insurance coverage that is 10 to 15 times your income. This ensures you’re getting enough coverage to financially support your family for the long term.

Tally up your financial obligations and subtract your existing life insurance policies and liquid assets, such as your savings accounts.

Even if you don’t have an immediate need for life insurance, you should get coverage as soon as possible. The cost of life insurance increases as you age and your health worsens, so purchasing a policy while you're younger is the best way to lock in more coverage for less.

Your beneficiaries can use life insurance money for virtually any expense. Typically it is used to cover funeral costs, college tuition, mortgage payments, and everyday bills and expenses.