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How Much Life Insurance Do You Need?

by Neal Frankle

I have a love-hate relationship with life insurance. On the one hand, I love it. It helped me get through college and have a life. It also helps me sleep at night knowing that my family would be taken care should something terrible happen to me (God forbid).

I also hate it because many agents misrepresent it. They sell you the wrong kind of insurance and the wrong amounts. Their primary objective is often to maximize their own financial security rather than yours. Don’t let their character flaws influence your decisions about this important topic.

Do you need life insurance?

Life insurance has only one purpose: to complete your financial responsibilities if you die. That’s it. If you have no dependents you don’t currently need life insurance. Don’t fall for a common trap: life insurance is not an investment.

If you do have dependents you should buy term rather than whole life. I’m going to assume you are familiar with term and whole life insurance. It is a good idea to familiarize yourself with your options.

how much life insruance do you need?

How much life insurance should you buy?

Remember, life insurance is meant to make up for your lost income. So we need to figure out how long your dependents will depend on your income.

One rule of thumb is to multiply your income by 17 and buy that amount of insurance. So if you bring home $48,000 a year you need $816,000 in term insurance. This is a rough estimate but let’s see if the rule of thumb works.

Without getting bogged down in lots of detail, let’s make some assumptions and break this down.

  1. You and your spouse are 45 years old.
  2. You each bring home $4000 a month for a total of $8000.
  3. You have one child age 7.
  4. You will retire in 20 years.
  5. The $8000 in monthly income allows you to save for your child’s education and your retirement.
  6. If one of you dies, your expenses will increase by $1000 monthly to pay for extra child care for 5 years.
  7. Inflation will be 3% over the next 20 years.
  8. Investment return will be 5% over the next 20 years.
  9. You already have $150,000 in savings.

So, in this example, you need to replace $5000 in monthly income for the next 5 years and then $4000 for the next 15 years. Tell you what, we’re just going to replace $5000 for the next 20 years and give the surviving spouse a little bonus for putting up with you as long as they did.

How much term life insurance do you need?

Go to this calculator and input your desired income ($60,000), number of years (20) and rate of return (2%).

We used $60,000 because that represents $5000 in monthly income for 12 months. We also used 2% for the rate of return which is 5% return less 3% inflation. Mathematically, that isn’t 100% the way to do it but it really is close enough for what we need.

Input those numbers and your result is $981,085. Now, subtract the $150,000 that you already have and you need to buy $831,085 in term insurance.

How long do you need it for? 20 years of course. By then, according to your plan, you’ll have enough to retire on.

In this particular example, the result is pretty close to the rule of thumb calculation. You should buy $850,000 in term life insurance. The best way to buy this coverage is to shop on the internet for free rate quotes or contact a life insurance agent to help you navigate your options.

If we want to complicate this issue, we’ll notice that the amount needed decreases each year. This exercise calculates the amount you need right now. You could easily re-run this exercise each year to see if you still need the same amounts.

Just remember two things:

  1. Only buy term life insurance for income replacement and family protection.
  2. Think of life insurance in terms of income replacement. How much income will you need and for how long?

Once you determine that, it’s easy to figure out how much you need to buy.

This is a guest post by Neal Frankle. Neal found himself in a financially fragile situation at the age of 17. Both his parents passed away while he was still in high school, leaving behind a small insurance settlement. Neal sought out a financial advisor to help him invest his nest egg so that it would help put him through college. Instead, the advisor charted a self-serving course and was on the verge of burning through the money when Neal realized what was happened and fired him just in time to avoid losing everything.

The experience had a deep impact on Neal and formed in him a lifelong desire to help people learn to make smart financial decisions. Today, with more than twenty-five years of experience in the financial services industry, Neal is an author and avid blogger.


Published or updated January 6, 2014.
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{ 36 comments… read them below or add one }

1 Curious Cat Investing Blog

Few people seem to realize as you age often you need less insurance. As you mention your “obligations” decrease. You also should have other assets saved up for your retirement that can be used for other purposes (paying off mortgage, children’s education…) if you are no longer around.

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2 Ryan

Curious Cat: That makes sense. I haven’t done much research into life insurance, so this guest post was a good primer for me. With our first child on the way I know I need to bump up my coverage (I only have a small policy through work). I’m sure I will need to periodically reevaluate my situation, but that should be done with all aspects of personal finance.

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3 DDFD at DivorcedDadFrugalDad

The rule of thumb for purchasing life insurance is take your youngest child’s age and subtract from 21– then multiply the result by your income– that’ how much you need.

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4 Miranda

Thanks for this great post. We have life insurance in an amount that will pay off our debts (mortgage, student loans) and provide some income replacement. Since we are living on my income right now, and I work from home, I’m not worried too much about my husband. So right now we have higher coverage on me, in order to help my husband while he finishes school — just in case. We probably should up our coverage, but between our savings and the coverage we do have, we feel pretty secure. We will increase my husband’s coverage when he finishes and gets a job.

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5 Ryan

Miranda: My wife and I have a small amount of life insurance right now as well, which is fine because we are both professionals and can handle our personal bills without any worries (all we have is a mortgage).

But we have a little one on the way and my wife will drop out of the workforce. I will need to buy both of us more life insurance in the even something happens to one of us. The plan will be to cover enough of our income that the surviving spouse wouldn’t have to work (or only work part time), that way they can take care of the child without incurring too much financial difficulty.

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6 Neal Frankle

DDFD – Never heard that one before…..thanks. That’s very good.

CAT -You nailed it. That’s why you need to replace your income INCLUDING savings.

Miranda – That’s a very smart approach. I assume you are both young so waiting a few years shouldn’t add to the premium very much.

Ryan -I salute you looking into this. Term is really cheap. I think you’ll be surprised how inexpensive it is considering the sleep-at-night benefit.

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7 Ryan

Neal: Thank you for the excellent article. My wife and I plan on discussing our needs and hope to purchase a better life insurance plan before our first child arrives in July. I currently have a small policy through work, but it certainly wouldn’t be enough. Thank you for the tips on how to determine how much insurance we will need. It will definitely help me sleep better at night. :)

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8 My Journey

Disclaimer: I work for a Wealth Managment/Estate Planning Firm that does sell insurance, however, that is not where I make my money.

Like most personal finance subjects this is NOT black and white, yet bloggers and talking heads try to make it so.

First of all, who the heck really buys terms and invests the rest? I mean come on, if that were the case we wouldn’t be nation of debtors LOL!

Second – I know it is not the norm, but most of my clients have an estate tax problem – it is a complicated situation I attempt to make easy, but suffice it to say lets say they don’t have the liquidity to the estate tax….we sometimes fix that problem with permanent insurance. This problem usually does not go away post 65.

Third – In your example – if husband dies at age 66, leaving a spouse, how long will that money last if she need long term care?

With all that being said, I currently have term insurance because I have outstanding debt to take care of…but I just wanted to show the unfavorable point of view that is often ignored.

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9 My Journey

Sorry just re-read…few mistakes LOL!

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10 Neal Frankle

Thanks for your comments My Journey. Here is my reply:
a. I am also a financial adviser and sell insurance.
b. Many of clients buy term and invest the rest. We set up systematic investment plans.
c. You work with clients who do need to look at whole life. That’s why I wrote “buy term for income replacement”. I didn’t say to buy it for estate planning needs. Whole life does have a place in the estate plan – but IMO that’s the only place.
d. Long term care is a very important issue and I’m glad you brought it up. I think a fair response to using whole life for long term care (please never ever do it) would require an article.
e. Thanks for your honesty about your term coverage. Also, thanks for your civility. Often, when people take issue, they do so in a rather aggressive manner and I really appreciate your approach. I don’t think that all insurance sales people are rotten – if you read my story, you’ll know why. I do however think that the product is often sold to the wrong people. If a client has $100/month and needs $1,000,000 in coverage, the whole life won’t solve the problem while the term may. I just don’t appreciate it when some agents sell the whole life in order to maximize their own financial well-being. I’m not saying you do this, but it does go on.

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11 My Journey

I hate when people are not civil on blogs…it ends up being a pissing contest with no real winner since so many of us are anonymous (in this case just me!) For purposes of “readability” I’ll respond according to your points.

B – I am impressed you are able to create that situation. That being said, I have to ask do you “invest the rest” in loaded mutual funds, or no-load bond funds? I do not judge either way, I only ask because I am curious how you make a living if you sell no-load mutual funds and term. Are you purely fee based?

C – You make a very valid point, and a lot of people do use life insurance as solely an income replacement vehicle. That being said, who is to say that income need doesn’t extend beyond age 65. This is my main problem with Term (vs. Whole Life or UL) – you don’t know whats going to happen in the future and the other options allow for a flexibility that is impossible with term.

D – I am not suggesting we use a Whole Life Product as a replacement for LTCi, rather I am asking why we only need that bucket of cash (or income replacement) until age 65 only. I am only using 65 because of your example, do you sell 30 year term to a 30 year old? What about if you see a 40 year old what do you do then? sell 20 and ignore that 5 year period? Again, I guess my point goes to the inflexibility of Term.

E – I always appreciate a good discussion!

If a client has $100/month and needs $1,000,000 in coverage, the whole life won’t solve the problem while the term may. I just don’t appreciate it when some agents sell the whole life in order to maximize their own financial well-being. I’m not saying you do this, but it does go on.

3 Points here:
(1) 1000% Correct as to the $100 bucks a month for $1mil in coverage. Which is why I have 250K term for 20 bucks a month.
(2) I get the anger with so-called financial planners who are nothing more than pushing product. I understand it and feel the exact same way.
(3) As to not saying I do this – I am actually a director here, hired for my knowledge with estate taxes (law degree). Despite having all my licenses I have yet to sell a product.

Ironic Story: After I commented a Planner came in my office and we were talking about funding a special needs trust with Life Insurance (I will write a post on this tonight, and if CashMoney allows me to, I will put the link up at another time). Despite it being a child, there is no point at which Income won’t be necessary to provide this child with special needs cash to purchase those items which medicaid wont’ cover. This little story provides two points:
a) A less than informed planner wouldn’t have put this money into a SNT thereby SCREWING this Family.
b) Term isn’t the end all be all, and people should at least hear out someone talking about another product.

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12 Wealth Pilgrim

My intent with Wealth Pilgrim is NOT to solicit clients so I’m not going to talk about how I work with clients – with your permission.

INCOME REPLACEMENT – I agree with you. My thinking is that people should have a plan whereby they could stop working by 65 but if not, they would need the coverage longer.

LTC – I feel that LTC coverage is stand alone. I think that TERM is actually very flexible.

Again, I respect your well made points and very much appreciate your civil delivery. I also really dislike the negative energy.

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13 Michael @ The Life Insurance Insider

I’ll second My Journey that there are legitimate other reasons to purchase life insurance other than income replacement and that other types of life insurance products that are better suited to match some of those reasons than term life insurance. Business succession planning, estate planning, and final expense planning are all legitimate reasons to purchase life insurance.

Your article makes some great points and people need to be careful of agents and financial planners making decisions that better suit their financial plan than that of their clients. I would hate for someone to get the impression that a financial planner or insurance agent recommending life insurance for something other than income replacement or recommending something other than term life insurance was automatically incompetent or trying to rip them off.

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14 Dan

I disagree with the notion that life insurnace is cheap per the recommendations of this article. To buy a 20-year policy at 17 x’s my current income – ouch. That’s a fairly significant additional monthly expense.

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15 Dan

I see no mention of personal health – that plays a huge role in the premium you’ll get. If you smoke, you’re shooting yourself in the foot as you’ll be paying much more for the same policy. If you’re on any kind of prescription drug they can possibly knock you down a status level for that as well.

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16 My Journey

Dan,

While this may not be appropriate but I think of term insurance as the bottom of a pyramid. Do you really need to be dropping in 500 a month into a Roth IRA (not saying you do – just making a point) if your family can’t survive past your demise?

Not sure if you do…but stop smoking! With the increase in the federal tax on smoking going from 39 cents to over a buck, now is as good as ever.

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17 Wealth Pilgrim

Michael, I agree. That’s why I said that term is THE solution (IMO) for family protection and income replacement. There are uses for whole life but they are limited.

Dan, I understand your point. It’s not cheap. But consider how expensive it would be for your family if you weren’t bringing home the money every month. Unfortunately, I lived through that. You don’t want to even consider that as an option…..

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18 Dan

Yeah, my two packs a day are costing me big now….

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19 My Journey

Dan,

WOAH 2 packs a day? Considering we are talking about stuff over the comment section I can’t tell if you are being sarcastic or not. But if you are serious you can’t possibly be bitching about the cost of life insurance.

Considering I like Ryan and his readers lol I decided to run a quote for you:
Lets say you are 45 and pay 300 a month for 30 Year Term – note that 300 is LESS than the amount of 2 packs a day ($5/pack X 30 – in NY a pack is over $7). This amount will buy you OVER $320,000 GUARANTEED.

I work for a AAA Rated (one of the few left) company that has been around about 150 or so years lol. Which means you CAN even get cheaper term somewhere else.

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20 My Journey

Again, I should repeat, I am not attempting to sell life insurance over the internet – To date, I have never sold a single policy (that may change eventually).

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21 Dan

I’ll probably try the patch – that’s the best life insurance policy I can buy!

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22 Dough Roller

Great article. It hit home for me because like the author, life insurance helped me get through college, too.

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23 Bret

I recently started an internship with a mutual company and am on the (never ending I assume) path to learn everything about each concept (whole vs. term) and each product so I can best serve my clients and have a lucrative career that allows me to sleep at night. I’ve read that the average person will make additions to their original commitment 5-7 times over their lifetime. From a purely financial standpoint, I would much rather see the first year commissions from all 5-7 purchases, even if it’s term, by best serving my clients needs and situations then to push a whole life policy in order to get more cash. And that’s purely a financial move, not to mention ethical. Every negative thing I’ve read about products, rates of return, and sales tactics make me feel more and more secure about my position with this company and the standards which they teach and promote. Granted, not every agent will follow those and act in the best interest of the client, but that’s really more of a comment on greed and human nature then that of companies or insurance products. If you’re thinking about making a wise decision with your finances (insurance, investments, whatever) then you should also be willing to put time and effort into researching and getting the facts before hand. Not to say that deception is excusable by any means, but I think the responsibility lies in the clients hands, in being knowledgeable and seeking council prior to any major financial decision, just as much as the agent or company. Simply put, term is good for what it does and whole is good for what it does. It’s just a matter of if “what it does” is what you need. My company may be paying 6.5% for a return which isn’t the 10% that people compare it to (btw they never mention what in the world is yielding 10%), but the principle is guaranteed to not go down and the policy and cash value will do (for the most part) what the ledger states in the beginning. We’re all grown ups, do your research and ask a lot of questions to people who are reputable and don’t stand to make a profit off of you.

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24 Dez

Humm, I take you IF I don’t have dependents but I have a sizeable estate, I don’t need insurance to pay taxes for the beneficary? IF I’m poor I don’t need insurance to pay for a funeral? If over 65 and I am married, my kids are grown, my spouse wouldn’t need to replace the lost income from my soical security nor would my spouse need to live after I’m gone?

I’ve never seen such a crazy statement.

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25 Miss J

Hey there. Insurance shopping. We have one child, 3 months old. Anyways…Are life insurance benefits taxed? Becasue my before tax and after tax incomes are VERY different and that makes quite a difference in how I calculate the “rule of thumb”.

Our son needs 21 years of “income replacement”. I make $78,000 a year (pre-tax) so I would need $1,638,000 in life insurance!? That seems like an awful lot… If I calculate it post tax then it’s still about 1.2 million which still seems like a lot…but maybe I’m just being naive about the whole situation…

Also, providing that if I were to die, my husband could take a lump sum of cash and pay off our 30 year mortgage we would save an INCREDIBLE amount on interest…so doesn’t that reduce the amount of life insurance we need? For instance our $235,000 mortgage comes out to about $1,600 a month of which a whopping $1,100 goes to interest right now. I know that as time goes on less and less of our payment will go towards interest…but still this mortgage interest factor must affect the calculation some how?

Currently I have 600K worth of coverage. 100K through work and a 500K whole life policy (don’t get me started on that…I feel really ripped off by the financial planner who sold it to me…but I digress). I feel like I need a little more coverage but not DOUBLE…what do you think?

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26 My Journey

Miss J,

Lot to digest but I feel you deserve some insight:

1) Life insurance is income tax free. As opposed to what most finaicial planners tell you – it is 90% of the time included in your estate for estate tax purposes (there are advanced ways to get it out of your estate). So, if you had assets totalling $500,000 and you had a $1,000,000 policy. You would pay 0 in federal estate tax (because you can leave up to $3.5 Mil to a non-spousal US bene) but you might hit a State Estate Tax if you live in one of 18 states which are decoupled.

2) Second your end number is $1.67mil or something doesn’t into account future growth of that money. If you are trying to get how much you need that way (e.g. Income Replacement) you need to do the present value of that number given a specific growth rate (I would use something really low because the kid is going to have to be conservtive so like a 2.5% NET to 3.5% NET).

3) In terms of the mortgage you should build an excel spread sheet seeing how much that takes off your husband’s need.

4) As you can tell from the above comments and my guest post on this blog – I like whole life insurance because you know why – 99% of us (including myself) do not buy term and invest difference! How much cash do you have built up in the WL? If it was int he last 2 or 3 years the number is 0, but if its 10 years deep you’ll be suprised how much cash is there, you can then do a lump sum 1 time pay off of UL or diff type of term.

JUST SOME THOUGHTS!

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27 teacher mom

I am trying to figure out how much life insurance to take out on my husband. He is an executive chef with no benefits. I am teacher with great benefits that will help my husband if something was to happen to me, me on the other hand…We are both 30, excellent health, two kids (3 and 4) what is a good plan?

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28 Ryan

Teacher mom, It is very difficult to answer your question because you don’t give enough information about your financial situation. The rule of thumb used in this article is 17 times the annual salary of the person in question, but that formula doesn’t always work for everyone or each situation.

You need to consider how much money you would need if one of you were to pass away. Take a look at your current expenses, possible future expenses (funding college, insurance, moving, etc.), possible changes to life situation (remarrying, for example), and try to determine how much you would need above your current income to reach those future expenses. You might wish to consider how much it would take to pay off any debt you might have, including your mortgage, then go from there.

In any calculation I would do, I would consider how much it would take to payoff the mortgage (or all debt), then add a buffer based on the assumption of how much I would need to maintain a decent lifestyle with my current income from working, with no house payment. There is no “exact’ formula because each situation is different, just guides that might make things a little easier. I hope these tips help.

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29 Dad S

I am looking at buying term insurance to replace income lost if something should happen to me (wife works but wish to leave her income out of the equation)…I make about 6K a month after tax but wondering how long of a term i should get…I have 15 years to retirement but have young kids, 2 and 5…since the youngest will still only be 17 when i retire, should i opt for the longer 20 year term or stick with the 15 year term to retirement? Also, as we have some assets built up, i am really only concerned about near term unexpected events and making sure the kids are comfortable through college…What advice can you offer?

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30 Ryan

Dad S, Term insurance should be cheap enough that adding a few years to your policy is probably worth it. You never know what will arise between now and then and having that extra time on your policy will probably help you sleep better at night. With most term policies you can drop it if you no longer feel like you need it. But adding a few years to your policy later on means you will pay premiums at the new rate. (for example waiting five years to change your policy might be more expensive than getting a longer term now).

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31 Leonard Robbins

Dad S, you may also want to consider “laddering” your policy(s). Remember that you can always purchase more than one policy from the same or different carriers as long as you inform each insurer of your plans. Also, when considering more than one policy, try to keep the amount at $250,000 or more since you will usually get a better rate than a lower amount.
Whatever you decide, you’re doing the right thing by thinking about it, rather than just pulling a figure out of the blue!

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32 Ryan

Here is something I don’t understand. In the example given, it was assumed that each spouse brought home $4000, but it was also assumed that every dollar of this $8000 per month would be spent on food, mortgage, savings, or child expenses.

But, this can’t be true. If I die, my family loses my $4000 a month. But they don’t need to replace my $4000 a month. See, I won’t need to eat, drive a car, or take a shower in the grave. So no food, car payments, nor water bills. And our retirement savings can be cut drastically as well. The NET income needs to be replaced, not every dollar that I bring home. Right?

Ryan

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33 Frank

Whole life is a total crock of BS for most people. It’s prohibitively expensive for almost anyone, at least for any significant death benefit. If you need anywhere between 500K and 1Mil, which is quite standard for most people using the 10 to 20X income formula, then have fun with those monthly payments on whole life. I don’t know how many people have an extra 3, 4, or 5 hundred bucks per month laying around, but I sure don’t.

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34 Stacy

I feel like life insurance is really important for people to have due to all the liability there is.

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35 Kirk Kinder

Very good article. I love how you look at the cash flow needs of the couple, not a generic rule of thumb. The rule of thumbs are so inadequate. A couple with lots of debt face a different situation than one that only has a mortgage. Also, people need to input their view of insurance. I tend to focus on cash flow needs that should be replaced due to a death. Others may want to also add extra insurance for retirement savings, college savings, etc. Insurance is a personal issue.

I also agree that term is key. Permanent insurance is needed in some instances, but for the vast majority of people, it is a waste.

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36 John Butler

Great article Neal, glad you focused on life ins. as income replacement. I think a lot of people would not have as many questions concerning life ins. ( cash value vs. term) if they had a complete written financial gameplan. Setting up accts. for immediate, short, mid and long term needs is critical. Without it we don’t understand how much we really need to save to become financially independent. That is the goal for our family.

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