How to choose the right life insurance death benefit

Shopping for life insurance means asking difficult questions and making tough decisions. For example, what's the right size death benefit for your beneficiaries?

Death benefit. If you’re buying life insurance, these two words are of paramount importance. It’s not such a bad thing if you overestimate the amount of money to leave your spouse and children (if applicable), but it can be a financial disaster for your family if you underestimate the amount of the death benefit.

What is a life insurance death benefit?

A life insurance death benefit is the amount of money that a beneficiary receives when a policyholder dies. It’s not to be confused with the “face amount” of the policy, which is the amount of money the beneficiaries would be paid when the policy was issued. The death benefit is equal to the face amount of the policy minus any unpaid loans.

For example, Ted was approved for a whole life insurance policy with a face amount of $100,000 specified in his policy. Five years later, Ted borrowed $25,000 from the policy’s cash value. He passed away six months later and had not repaid any of the outstanding policy loan. Ted’s beneficiary received a death benefit of $75,000 ($100,000 face amount minus $25,000 outstanding loan balance).

How much should your life insurance death benefit be?

Would it surprise you to find out that the three most common death benefits for life insurance policies are $50,000, $250,000, and $500,000? It’s interesting that they’re all round numbers and are all multiples of $50,000. This is a pretty good indicator that many life insurance death benefit amounts aren’t arrived at using any type of formula; rather, they’re guesstimates of what a family needs.

However, some people want to be more methodical and precise about how much life insurance they should own. They can use two primary methods to calculate this: the “multiples of income” method or a calculation using “DIME.” Let’s look at both.

Multiples of income

Also known as the “life insurance rule of thumb,” it isn’t as precise as DIME, but there is some logic to it. With this method, you take your annual income and multiply it by 10 to 15. For example, if you earn $50,000 per year, you could multiply that by ten, and you would want a death benefit of $500,000; if you multiply the $50,000 by fifteen, the recommended death benefit would be $750,000.

The multiples of income method is one way to arrive at a death benefit amount, but how accurate is it? What should your multiplier be? 10 or 15? In the example above, the death benefit was 50% higher using a multiplier of 15 – a substantial difference. Though using this method will result in an approximation, it can act as a catalyst to get someone confident enough to apply for a policy to protect their loved ones.

The DIME method

DIME is an acronym that stands for Debt, Income, Mortgage, and Education. Using the DIME method takes some time and energy to calculate the death benefit, but it will provide you with a more accurate number than multiples of income.

With DIME, add up its components to arrive at a death benefit:

Outstanding debts + your income multiplied by the number of years your family will depend on it + your mortgage balance + the projected cost of your children’s education.

For example, using DIME, Richard would arrive at a recommended death benefit of $1,975,000 based on:

  • Outstanding debts: $25,000 on credit cards
  • Income: $1,000,000 ($50,000 needed by family for 20 years)
  • Mortgage balance: $350,000
  • Education: $600,000 ($75,000 per year for 2 kids for 4 years)

As you can see, there is a very substantial difference in what the multiples of income method would have recommended for Richard - $750,000 (annual income x 15) versus the DIME recommendation of almost $2 million.

Learn More: How Much Life Insurance Do I Need?

Who will receive the policy’s death benefit and when?

When someone completes an application for a life insurance policy, they must name an entity (person(s), college, charity, etc.) to receive the death benefit. This entity is called the “primary beneficiary.” They also can name a “secondary beneficiary,” which is another entity that would receive the death benefit if the primary beneficiary was deceased or no longer available to receive the death benefit.

How long it will take the primary beneficiary to receive the death benefit will vary from insurer to insurer. Once a claim form and death certificate are submitted, receiving payment between 2 and 4 weeks is considered reasonable.

There could be a delay in payment if an investigation were to be conducted by the insurance company concerning the cause of death or the circumstances surrounding the death.

For example, life insurance policies contain a “suicide clause,” meaning that they won’t pay a death benefit to a beneficiary if the insured person commits suicide within the first two years of the policy’s issue date. If the insurance company suspects that the insured individual did indeed commit suicide, they can take a reasonable amount of time to obtain medical records and autopsy results to determine the validity of the claim.

Learn More: Naming a Life Insurance Beneficiary

How can beneficiaries use a death benefit?

It depends on whether or not the death benefit is paid directly to the beneficiary or if it’s paid to a trust.

If the death benefit is paid directly to an individual, such as a spouse, that person can spend the death benefit any way they see fit. It could be used to pay off a mortgage, or it could be used to travel extravagantly and see the world. It’s entirely up to the beneficiary.

If the death benefit is paid to a trust, the person who carries out the term of the trust (the “trustee”) can determine how the death benefit is to be used. For example, a parent may create a trust for their younger children with the stipulation that they will receive $50,000 per year for four years when they turn age 18, and the money must be used for college tuition.

Are death benefits taxable?

Generally, death benefits paid to a beneficiary are not subject to any capital gains tax or income tax.

However, estate taxes can be due under two circumstances:

  1. The entire death benefit is included in the estate and subject to estate tax if the estate is named the beneficiary.
  2. The whole amount of the death benefit is included in the estate and is subject to estate tax if the deceased both owned and was insured by the policy on their date of death.

The ownership and selection of beneficiaries can get complicated at times. A competent financial advisor or estate planning attorney can provide guidance when you purchase life insurance and are unsure how to structure it.

Learn More: Is Life Insurance Taxable?


Having grown up in upstate New York, Bob Phillips spent over 15 years in the financial services world and has been making freelance writing contributions to blogs and websites since 2007. He resides in North Texas with his wife and Doberman puppy.

The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.