Earlier this year, we wrote a blog about Financial Rules of Thumb to be used when you need a “ballpark number” or a “reasonable guess” to some of your financial questions. The answers we get from applying these rules of thumb are meant to be approximations, not iron-clad certainties. Sometimes having a general idea is all we need to move forward. With this in mind, here are a few more financial rules of thumb to help you make financial decisions.
Amount of life insurance needed
The answer to the question of how much life insurance you need is, “It depends.” It depends on the needs of those you want to protect, how much you can afford for premium payments, your age, your debt load, and the amount of other financial resources available in case of an emergency. But for a handy rule of thumb, try to obtain 10 times the amount of your gross salary. That means if your salary is $100,000/year, you would aim to secure a life insurance policy that pays a death benefit of $1 million. If you are married and you both are bringing income to the household, each spouse should obtain life insurance to protect the other. If your spouse earns $50,000 per year, aim for a $500,000 death benefit (10 times the $50,000 yearly earnings of your spouse).
Income needs in retirement
A standard rule of thumb is that you will need 85% of your pre-tax income in retirement. That means if you are earning $100,000 before retirement, you will need an income of $85,000 in your retirement years. Remember that there are two financial life stages – the accumulation years, when your goal is to save 15-20 percent of your gross salary for retirement, and the distribution phase, when you have finished your working years and are living off of your personal savings, pensions, and Social Security income. Once you are retired, you no longer have the expense of saving for retirement. So shoot for being able to provide yourself a yearly income of 85% of your ending salary.
A traditional rule-of-thumb that lenders use when approving loans is that housing payments should not exceed 28% of monthly gross income. Combined debt payments, which includes mortgage, credit cards, student loans, etc., should not exceed 36% of monthly gross income. These percentages may vary with individual lenders and your unique situation, but like all rules of thumb, this one gives you an idea about a reasonable starting place when considering adding a mortgage to your debt load.
Rules of thumb are always approximations. If your situation is at all unique, you shouldn’t rely on guesses and estimates. Being specific is almost always better. After all, a little bit of time, effort, and cost now may bring big rewards in the long term.
Andrea L. Blackwelder, CFP®, ChFC and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with Wisdom Wealth Strategies.