Using life insurance to replace your income can provide your beneficiaries with the funds they need to cover expenses after you die, while also providing you with peace of mind. According to a new InsuredCircle survey conducted online by The Harris Poll, nearly one-third of Americans who purchased coverage did so for income replacement.

Learn more about the income replacement method of life insurance and how to calculate your coverage amount.

Why it's important to have life insurance to replace your income

A breadwinner's income loss can be devastating for a family, and many people do not have enough savings to cover such an event. According to the 2022 Insurance Barometer Study from LIMRA and Life Happens, nonprofit insurance trade associations, 44% of American households say they would face financial hardship if the primary wage earner died after six months.

Life insurance, like many other insurance products, provides coverage for the unexpected. A life insurance payout is made directly to your beneficiaries, who can use it to cover ongoing expenses in your absence.

Even if you are not the primary earner, loved ones may rely on the services you provide — and income replacement can assist them in paying for those services while you are away. Whether you are a stay-at-home parent, one of several breadwinners in your household, or the sole breadwinner, a life insurance policy can provide financial security to those you leave behind.

What type of life insurance can replace your income?

In general, there are two kinds of life insurance: term life insurance and permanent life insurance.

Term life insurance covers you for a set number of years, such as 10, 20, or 30. It is typically the least expensive type of coverage and is adequate for the majority of families. You can match the length of your term policy to the amount of time you want coverage. A 20-year term life policy, for example, could cover your income while your children are still at home, whereas a 30-year policy could cover your income for the majority of your working years. If you die during the policy's term, your life insurance beneficiaries receive the death benefit. Ideally, by the time the term ends, your loved ones will be able to support themselves and you will no longer require coverage.

A permanent policy, such as whole life insurance, pays out regardless of when you die and is typically more expensive than term life insurance. According to Quotacy, a brokerage firm, the average annual rate for a 20-year, $500,000 term life policy for a 30-year-old woman is $190; for the same client, the average annual rate for a $500,000 whole life policy is $4,143.

If you're only looking for a policy to replace your income, you might not need permanent life insurance. Those who rely on you now may be financially secure by the time you retire, eliminating the need for lifelong coverage.

How to calculate income replacement

One rule of thumb for determining how much life insurance you need to replace your income is to multiply your annual salary by the number of years you want to cover. For example, if your annual salary is $60,000 and you want to provide five years of coverage to your beneficiaries, you'll need a $300,000 policy. Keep in mind that this is only your starting salary. You should also factor in any anticipated raises and additional costs, such as  college fees.

You may have heard the "ten times income" recommendation floating around the internet, but there are no hard and fast rules for calculating coverage. If you want more advice on how much coverage to get, speak with a fee-only advisor. Because these advisors are not compensated by insurance companies, they are not influenced by the amount of coverage you purchase.

Include daily tasks in your calculations

When calculating your coverage amount, consider the value of daily tasks. If you die, any free child care, cleaning, or cooking you provide may be costly to replace. According to 2020 data from Care.com, an online marketplace for family services, the average weekly cost of a nanny in the United States is $612. According to Care.com, a house cleaner typically costs between $15.50 and $20 per hour, based on pay rates in 20 cities across the country. If you're a stay-at-home parent, you're probably doing these tasks for free, and replacing them would be expensive. In your absence, a life insurance policy can help pay for these services.

Take into account any workplace coverage

If you have group life insurance through your employer, you should factor in the additional coverage amount in your calculations. However, keep in mind that these policies are sometimes linked to your employment, which means you may lose coverage if you quit.

Reevaluate coverage if your income changes

If your job, income, or family situation changes, you should reassess your life insurance needs. To supplement your existing coverage, you may want to purchase more than one life insurance policy. You can also change your coverage if you become the sole breadwinner or if your expenses rise or fall.

Important: Your ability to increase or decrease the death benefit amount may be limited by the insurer. If you believe you will need to change your coverage in the future, inquire about adjustment options before purchasing.