UPDATED: Mar 26, 2020
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Congratulations — you’ve taken a big, first step toward getting a new policy. Now, you just need a quote. But before you go and plug that magic number into a life insurance website, think about how much term life insurance you can qualify for.
You see, many life insurance shoppers believe they can buy any amount of coverage they want. Want $500,000? No problem. $5 million? You got it.
Only it doesn’t work that way.
You Must Qualify — Financially.
You likely already know you have to qualify medically for life insurance through a process called underwriting. The life insurance company is going to verify that you are in good health before they issue a policy to you, for obvious reasons.
What you may not realize is you have to qualify financially for life insurance as well. The reason for this is simple: the life insurance company is trying to prevent an excess coverage situation. The company needs to ensure that if you die, your total coverage amount doesn’t exceed your beneficiary’s economic loss. This is how they protect themselves financially and, in turn, can keep life insurance costs reasonable.
Financial Justification is All it Takes.
The core purpose of life insurance is to protect something: your family, business or estate are just a few examples. The policy’s death benefit is the amount of money the company pays your beneficiary if you die. That money can do many things, such as:
- Replace your lost income
- Pay off your mortgage
- Pay your children’s college expenses
- Pay your estate taxes
- Keep your business going
- Help a charitable cause
Your agent or company representative may use the word justification at some point. This means the life insurance company wants you to justify the amount of coverage you’re asking for. What is your annual income? How much is your net worth? Remember, life insurance is meant to protect wealth, not to create it.
These Financial Guidelines Will Help.
Life insurance companies use a multiple of your annual income as the basis the amount of coverage you can buy. These multiples look something like this:
|Life Insurance Rate Bands|
|Policy Amount||$100K – $249K||$250K – $499K||$500K – $1M||$1M+|
|Cost per Unit||$0.49||$0.45||$0.40||$0.37|
So if you are age 35 and make $50,000 a year, right off the bat you should qualify for $1.25 million of total life insurance. That’s total, as in, combined with any other policies you already have and intend to keep.
Remember this is just a starting point. The company will often consider other factors such as your net worth, asset portfolio or business operations to determine if you can qualify for more than this baseline.
It’s interesting to note that most life insurance companies will not ask for proof of income for smaller policies. Additional requirements like this usually kick in around $3 million and up. For these larger policies, you may be asked to provide additional financial information such as:
- W-2 statements
- Pay stubs
- Financial questionnaire
- Tax returns
Non-Working Spouses Need Life Insurance, Too.
And life insurance companies know the importance of this as well. So most have guidelines in place to cover you if you don’t have an income of your own. These rules range from 50 percent of the spouse’s life insurance amount all the way up to 100 percent.
There are usually limits on the maximum amount allowed for non-working spouses, with the most common being $1 million. However, some allow more. Genworth Life Insurance Company allows a non-working spouse to buy a policy up to 100 percent of the income-earning spouse’s coverage to a maximum of $3 million!
Know Your Number Before You Apply.
When you decide to apply for term life insurance, have some idea of how much coverage you need. Then use the multipliers above to see if you can qualify based on annual income alone. If not, be prepared to justify the additional amount of coverage you’re asking for.
It’s not enough to just throw numbers at the wall and see what sticks. Ask your agent to help you present your financial situation to the company in the best light possible.