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The exact advice I give to my financial planning clients when they ask me how much life insurance to buy

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  • There are three groups who always need life insurance: married couples, people with dependents, and co-business owners.
  • I advise married couples to get enough life insurance each to cover any debts, including mortgages and student loans.
  • Those with dependents should get enough life insurance to replicate your income for a specified period of time, such as through your child's 18th birthday.
  • For co-business owners, each should obtain enough life insurance to "buy out" a co-owner's heirs if one partner should die.
  • Policygenius can help you compare life insurance policies to find the right coverage for you, at the right price »

Life insurance is an integral part of financial planning, and you'll need it if anyone depends on your income (including a spouse, child, family member, or business partner). Beyond knowing if you need it, it's important to evaluate how much life insurance is appropriate. 

There are so many ways to approach this question, but for the purposes of this article I'll address the needs of three groups: married couples, anyone with a dependent, and business owners. 

There is no right and wrong answer, as every financial situation is unique, but here is how much life insurance I advise my clients to get.

Married couples

For couples without kids, one approach to consider when deciding how much life insurance to buy is the amount of debt maintained by the couple, which can include items like student loans, mortgages, car loans, and credit cards. Let's illustrate with a relatively straightforward example.

Jack and Sarah have been married for eight years, but decided early on in their marriage not to have any children. The couple has been diligent with managing their money as they have no car loan or credit card debt, but still maintain a mortgage of approximately $200,000. 

Upon getting married, Jack and Sarah both decided to purchase $500,000, 10-year term insurance policies with each other as the beneficiary. Unfortunately, Jack dies after battling an illness, which is devastating to Sarah. Jack's term policy is still in force, so Sarah receives $500,000. She uses these life insurance proceeds for mortgage payoff and invests the remaining amount $300,000 for retirement. The money will never replace Jack, but throughout her grieving, Sarah maintains peace of mind as she knows that everything will be OK financially.

Anyone with a dependent

The most common people in this group are those with children who are minors. The approach here is to obtain a life insurance amount with the purpose of income replacement for a specified period of time. In other words, the amount of money received by your heirs would be enough to "duplicate" your income if you were to die. Take the following example, which should provide more clarity.

Mark and Kate, a married couple, have a child who is 2. Their household income totals $200,000 (both of them have annual salaries of $100,000). They hire Sue, a financial planner, who recommends that they immediately obtain life insurance policies. She recommends Mark and Kate both get $2 million, 20-year term insurance policies and list each other as the beneficiary. The rationale is that the coverage lasts until their child completes college (around age 22) and the amount of insurance is 20x each of their $100,000 annual salaries. 

Ultimately, it would be the surviving spouse's decision on how to manage, invest, and use this cash windfall, but in theory, the total amount received can "replicate" the deceased's income over 20 years.

Business owners

Obtaining life insurance is a very prudent choice for business owners (including solo practices and firms with multiple owners). For the purpose of this article, I will focus on businesses with multiple owners. An approach is to get a life insurance amount that adequately funds a buy-sell agreement, which provides instructions for how a partner's share of a business is reassigned if that partner dies, becomes disabled, or retires. Let's illustrate with a simple example.

Jennifer and Dawn are both Certified Public Accountants (CPAs) and co-owners of a local accounting firm that has been in practice over the last 15 years. They started this firm together, and its economic value has significantly increased over time. 

Jennifer and Dawn hire Beth, a financial planner who specializes in working with small business owners. A planning goal is to make sure that their respective heirs would not be "stuck" with ownership if one of them was to die, but they still would want their heirs to receive an appropriate amount of money given the firm's value. 

Beth recommends that they first create an agreement indicating that if one owner dies, then the other assumes 100% of the company. Next, she helps them find a business appraiser who values their company at $2 million. The final step is for both Jennifer and Dawn to obtain $1 million life insurance policies listing each other as the beneficiary, which can fund their buy-sell agreement. In the event of one of them dying, the surviving owner would use the $1 million of cash (received from the deceased owner's life insurance policy) to buy out the 50% ownership from the deceased's heirs.

Martin A. Scott, CFP, is the founder and financial planner of Lasting Wealth Principles, a fee-only comprehensive financial planning firm.

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