Life insurance is confusing and complex. However, it can be one of the most important personal finance products that you ever purchase. If you were to die earlier than expected, life insurance ensures that your surviving family is taken care of. But how much life insurance is enough? One of the most recommended calculations is the DIME Rule.
DIME stands for Debt, Income replacement, Mortgage, and Education. You can get good guidance on how much life insurance coverage you need using these 4 items.
If you are in the market for life insurance, or just wondering if your current coverage is adequate, the DIME rule is a good place to start.
What Is Life Insurance?
Life insurance is a product that pays a death benefit to the person you choose if you die while covered. In exchange for this coverage, you pay premiums to the insurance company.
There are 2 main types of insurance, term and permanent insurance.
Term insurance has a maturity date. And if you don’t die before the policy expires, you typically get no payments back from the insurance company. Whereas, permanent insurance will cover you for life until you die, as long as you pay enough premiums.
Since there is a chance you don’t get a benefit payment under term insurance, it is significantly cheaper than permanent insurance. Usually permanent insurance costs 5-15x as much as a similar sized term product.
Life insurance is vital for protecting your loved ones in case you die. It is one of the key products in the protection bucket of the 5 pillars of personal finance. Life insurance can seem expensive, but remember, a life insurance product provides peace of mind.
DIME Formula
The DIME formula is one of 5 main calculations of life insurance needs. Under the DIME rule, you purchase enough life coverage that your debt, income, mortgage, and education needs for you and your family are met.
These calculations serve as a guideline, or base number, to work with. You may want to make adjustments based on your specific situation.
How To Calculate The DIME Formula
To calculate your DIME rule for life insurance you take:
- Debt: Any outstanding debts like student loans, car loans, credit card balance, etc.
- Income replacement: Add your annual salary multiplied for the number of years you want covered. For example if you are 35 and want to cover your income till retirement, you would take your salary x 30
- Mortgage: Add your mortgage balance on your house
- Education: Add in any future education expenses you want to cover for your children or grand children
Once you have this number, you adjust it down based on your current insurance coverage and any self-insurance or retirement savings you have.
There is simplicity and thoroughness in the DIME method. Once you have the above base number you can make adjustments based on major life factors.
If you don’t have kids or your spouse is self-sufficient, you may need less life insurance.
If you plan to care for your elderly parents or want to leave a legacy gift to a charitable cause you care about, you may need more life insurance. Additionally, if want to have funeral costs covered or a large, decorative burial, you may increases your coverage.
Benefits of the DIME Rule
The DIME rule includes all your major expenses, debts, and income replacement in its calculation. This makes it a more refined rule of thumb than income multipliers like the ‘rule of 10’. The rule of 10 just has you purchase 10x your annual income as life insurance. If you make $50,000 a year, you buy $500k of coverage.
If two people each make the same income. But person A has a paid off house, no kids, and no debt. While person B has a big new mortgage, kids they want to pay for college, and student & auto loan debt. Using a 10 times income multiplier may lead to person B being very underinsured. The DIME formula will account for all the large outstanding debts.
Additionally, the DIME formula avoids projecting out future items, unlike the human life value formula. But you can further refine the DIME result by projecting growth rates in your income and in the cost of college. This will likely result in higher insurance coverage needs.
Downsides of the DIME Rule
The DIME calculation does involve a few extra steps than a simple income multiplier, adding some complexity. Additionally, the DIME method has you buying insurance (a long-term contract) based on a snapshot of your financials. You could get a very different number if you pay down debts, save heavily, and make excess payments on your mortgage over a few years.
Do you think there is a chance your insurance coverage needs may decrease in the future?
You have options ways to better align your coverage. First, you can purchase a term life insurance ladder with numerous small policies that run-off over time.
If you purchase your term products through a large life insurer, you likely have options to extend your term coverage. The 2 most common are the term conversion rider and the post-level term annual renewable term option.
Another option is to purchase decreasing face term insurance. This is an insurance product that coverage declines over the life of the policy. It can be used to align your coverage with the pay-off of debt or financial obligations. Mortgage protection insurance (MPI), that has a face amount that decreases with your mortgage balance is an example of decreasing term. Although, most MPI products are relatively high cost and may not be right for you.
Alternatives to Calculate Your Life Insurance Needs
There are alternatives to the DIME rule. Four common alternatives are:
- Multiplier on Income: Set your life insurance coverage at a multiplier of your annual income. Usually 10-15x income is recommended
- Human Life Value / Projected Future Income: Your life insurance need is all your future earnings
- Monthly Premiums as a % of Income: Figure out your budget amount for life insurance and purchase as much coverage as you can afford
- DEEM FormulaTM / Future Expected Expenses: DEEM formula is like DIME except instead of using income, you use future expected expenses in the calculation
We think the DEEM FormulaTM is a better alternative to DIME. Since the purpose of life insurance is to provide for your loved ones. You don’t need to replace an income, you need to cover the expenses they incur.
The Final Word – DIME Rule For Calculating Life Insurance Needs
The DIME rule helps you establish a baseline for your life insurance coverage needs. DIME stands for Debts, Income replacement, Mortgage, and Education.
There are alternatives to calculate life insurance needs that are simpler (‘rule of 10’) and more complex (human life value). Therefore, DIME formula is a good middle of the road approach. And more importantly, it includes your major expenses, meaning your loved ones will be protected.
DIME stands for Debt, Income, Mortgage, and Education. The DIME rule sets a starting life insurance coverage amount at a number to cover all 4 of the categories:
1) Debt: Any outstanding loans – ie student loan, car loan, or credit card balances
2) Income: However many years of your income you want to replace
3) Mortgage: Outstanding mortgage balance
4) Education: How much education costs you want to provide for your children
You subtract any life insurance you currently have, including self-insurance & savings. The resulting number is how much life insurance coverage you need.
The simplest rule of thumb for life insurance coverage need is the “rule of 10” which uses 10 times your annual salary as a starting point. However, this can be too simplistic and underinsure people, especially those with mortgage and debts. The DIME Formula is a good alternative to the rule of 10, and includes Debt, Income replacement, Mortgage, and Education (DIME).
Yes, some common alternatives to calculate your life insurance coverage needs are:
1) Income Multipliers: “Rule of 10” or “Rule of 12” state to have 10x or 12x your income in life insurance coverage
2) Human Life Value: Project out all future income and hold that much insurance
3) Budgeted Monthly Premium: Figure out how much life insurance premiums you can afford, and buy that much coverage. Usually 1-6% of your monthly income is recommended to be used on life insurance.
4) DEEM FormulaTM: Similar to the DIME formula, but using expected expenses instead of income.