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How much life insurance do I need?

Life insurance will provide financial protection and security to your loved ones, but determining how many you need can be difficult.

According to Tom Nicoski, senior vice president and head of insurance for U.S. Bancorp Investments, the solution is dependent on your age and the reason you are purchasing a policy.

The below are few scenarios that will help you determine how much life insurance you need.

If you need income replacement

You'll need life insurance to replace your salary if you have a small family or a dependent partner. According to Nicoski, the aim is to ensure that your family will retain the same quality of life for the far future.

He goes on to say that the rule of thumb is to buy an insurance policy worth 8 to 10 times your taxable salary. For example, if the annual income is $100,000, he suggests purchasing a $1 million death care insurance policy.

But that's just the beginning. Younger people also purchase contract life insurance, which offers coverage for a set amount of time before expiring. A policy can last for ten, twenty, or thirty years and is comparatively inexpensive.

That means you should think about not only your current salary, but also your future earnings prospects. Those earning $100,000 today may earn $150,000 in five or ten years. (It's also worth noting that life insurance proceeds aren't usually taxable.)

“Don't be afraid to buy more than you'll need right now,” Nicoski advises. “Just because of the premium, it makes sense to get much more protection than you need.”

Remember your family's unique situations, such as the age of your children, when you want to have more, and how much your partner receives. If you have a young family, you will want to consider a 20- or 30-year strategy. You should consider the time-worth of capital and how inflation can reduce the benefits' value over time.

You might want to prefer laddering policies rather than purchasing a single broad scheme. You could purchase a 10-year term life insurance policy and a 20-year term life insurance policy, for example. This will give the surviving partner a financial cushion to pay expenses for daycare when pursuing a job.

“Some claim you'll need more as your family grows,” Nicoski says. “It's just a matter of the process.”

If you need living benefits

Life insurance requirements evolve over time. When people get older, they're less concerned with their ability to financially support their families and more concerned with the financial risks of their own long-term care. The positive thing is that certain life insurance plans have a rider that can be used as long-term care insurance (LTCI). According to Nicoski, if the insurance incentives aren't needed for long-term treatment, they become eligible as a death bonus.

The amount of coverage required varies depending on the individual, but it usually falls between $500,000 and $750,000.

If you need to leave a legacy

Life insurance will be used to leave an inheritance to a loved one. For instance, you would like to give each of your three children $500,000. In that scenario, a $1.5 million death benefit life insurance policy will be appropriate.

If you need to pay estate taxes

In 2020, a married couple will leave their heirs $23.16 million without having to pay federal estate or inheritance taxes. 

Families can have to sell illiquid assets above that limit, such as a property, company, or other real estate, in order to cover the levy. Beneficiaries will be able to protect the assets by purchasing a life insurance policy and death payments that offset projected estate taxes.

If you’re a partner in a business

If you co-own a company, you should think about purchasing a life insurance policy for your business partner. Many companies have buy-and-sell deals that enable a living partner to buy out a deceased partner's heirs. For eg, if you and a partner both own 50% of a $5 million firm, you'll want a $2.5 million death payout on your life insurance policies. Before you buy a scheme, make sure you have a fair-value valuation of your business.

Life insurance is an integral part of financial planning, and determining the appropriate amount can be difficult. Nicoski said, "It really circles back to the strategy you put together with your financial adviser." “Consulting with a lawyer on your life insurance options will help, regardless of whether you're doing it.”

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