©2015, college for financial planning, all rights reserved. session 9 life insurance needs...

©2015, College for Financial Planning, all rights reserved.

Session 9Life Insurance Needs CalculationsPolicy Replacement Decisions

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMFinancial Planning Process & Insurance

Session Details

Module 6

Chapter(s)

2 & 4

LOs 6-2 &

6-5

Analyze a client’s financial situation and goals to calculate the amount of life insurance needed under either the annuity or interest-only method.

Evaluate factors that might influence the decision to keep or replace a policy.

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The Winn Family StoryRodney Winn is 38 and married to Margaret, who is 36 (Step 8). Their children are Jacob, age 17, and Susan, age 15 (Step 5, Step 7). All family members are in good health. The children plan to attend the local state university for $6,000 per year (Step 6). They will begin college at 18 and end when they are 22 (Step 6).

Rodney’s monthly take-home pay is $2,100 (Step 5); as a receptionist, Margaret’s monthly take-home pay is $950 (Step 5). They describe themselves as having a low risk tolerance:

• Their net worth is $175,000.

• They have $34,000 in liquid assets (Step 1, Step 4), which is well above the recommended three months’ emergency fund to cover fixed and

variable expenses.

• Their nonliquid assets (Step 2) total $12,500.

• They have approximately $20,000 (Step 3, Step 4) in liabilities.

• They move $6,500 into savings annually.

Margaret would most likely liquidate the majority of assets in the event of Rodney’s death.

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The Winn Family Storycontinued

Rodney has a $25,000 group term life insurance policy and the family has adequate health and major medical coverage, making a last-illness fund unnecessary. They expect $4,000 will cover minimal estate transfer and funeral costs (Step 3, Step 4). They’re not counting on Social Security to be available in the near future for their age category, so they want Social Security, death, and retirement benefits to be ignored.

They feel an after-tax return on their investments of 7% is reasonable (Step 5, Step 6, Step 7, Step 8) and that inflation will average 5% (Step 5, Step 6, Step 7, Step 8) over the long run.

Margaret wants to maintain her current lifestyle through retirement if something were to happen to Rodney. Her needs will be substantially reduced after the children complete college.

The Winns project that after the kids leave home, Margaret’s income needs will be half of their current income needs ($36,600 ÷ 2 = $18,300 [Step 7, Step 8]). They expect half of this amount to be provided by Margaret’s pension plan retirement benefits when she turns 65. At retirement, Margaret wants to have a guaranteed lifetime income for herself.

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Life Insurance Needs Determination Worksheet

Step 1Gather information from the client.

Step 2Estimate fair market value of assets owned.

Assets Fair Market Value

Liquid $34,000

Total Liquid Assets $34,000

Nonliquid $12,500

Total Nonliquid Assets $12,500

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Step 3Determine liabilities to be paid off if client dies.

Liabilities Amount

$20,000

Total Liabilities $20,000

Estimate postmortem expenses.

Postmortem expenses $4,000

Total postmortem expenses $4,000

Total of Step 3 $24,000

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Step 4Determine liquid assets remaining, if any, after subtracting estimated liabilities and postmortem expenses.

Total liquid assets $34,000

Subtract estimated liabilities andpostmortem expenses (Step 3)

($24,000)

Total of Step 4 $10,000

If the TOTAL is greater than zero, the amount represents remaining liquid assets after total liabilities and postmortem expenses are paid. If the TOTAL is less than zero, the amount represents the amount of insurance needed for estate liquidity.

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Step 5 – Dependency Periodfor youngest child, age 15 until age 18

Estimate funds needed to provide all dependents with income until youngest child reaches age 18.

a. Desired monthly income $3,050

b. Expected monthly after- tax earnings of spouse

$950

Expected monthly Social Security benefits

0

Other monthly benefits 0

Total of Step b. $950

c. Step a. minus Step b. $2,100

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Step 5continued

d. Multiply by 12 to arrive at annual total payment

$25,200

e. Serial payment calculation: 3 number of periods 5 % inflation 7 % after-tax yield

Calculate present value of annuity due (PVAD)

Total Amount Needed in Step 5 $74,196

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Step 6 – Education CostsChild: Susan

Annual college costs (current) $ 6,000

a. Inflation adjustment calculation: 3 number of periods until child begins college 5 % inflation

Inflated future value of first year’s tuition $6,946

b. Serial payment calculation: 4 number of years in college 5 % inflation 7 % after-tax yield


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Step 6continued

Calculate present value of annuity due (PVAD)

$ 27,014

c. Discount calculation: 3 number of periods until

student begins college 7 % interest/yield

Calculate the present value of the above PVAD

$ 22,051

Total amount needed in Step 6 $ 22,051*

*only Susan is included.

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Step 7- Blackout Periodfor age 39 until age 65

Estimate preretirement income fund for spouse after youngest child reaches age 18.

a. Desired annual income for surviving spouse $ 18,300

b. Expected annual after-tax earnings and benefits of spouse

$ 11,400

c. Subtract Step b. from Step a. $ 6,900

d. Serial Payment Adjustment Inflation calculation:

3 number of periods until serial payments begin 5 % inflation rate

Calculate the future value of the needed income when serial payments begin

$ 7,988

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Step 7continued

Serial payment calculation:

26 number of periods between date when youngest child reaches age 18 and retirement

5 % inflation rate 7 % interest/yield

Calculate PV of annuity due (PVAD) $ 165,699

Discount calculation: 3 number of periods until serial payments begin 7 % interest/yield


Total amount needed in Step 7 $135,260

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Step 8-Retirement for age 65 until age 85

Estimate retirement income fund for spouse.

a. Desired annual income for surviving spouse at retirement

$ 18,300

b. Expected Social Security, retirement or other benefits of spouse

$ 9,150

c. Subtract Step b. from Step a. $ 9,150

d. Serial payment adjustment inflation calculation: 29 number of periods until retirement 5 % inflation rate

Calculate the future value of the needed income

$ 37,663

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Step 8continued

Serial payment calculation: 20 number of periods of retirement income 5 % inflation rate 7 % interest/yield

Calculate PV of annuity due (PVAD) $ 633,381

Discount calculation: 29 number of periods until retirement 7 % interest/yield


Total amount needed in Step 8 $ 89,030

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Step 9Estimate the amount needed for an emergency fund (supplied for this example).

$ 9,150

Step 10Determine insurance needs (summary).

a. Add amounts determined by:

Step 5 $ 74,196

Step 6 $ 22,051

Step 7 $135,260

Step 8 $ 89,030

Step 9 $ 9,150

Total financial needs $ 329,687*

*With Jacob’s $22,899 for education the answers are identical.

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Step 10continued

b. Total resources available (remaining liquid assets from Step 4)

$ 10,000

c. Subtract total resources available in Step b. from the total actual needs in Step a. to determine insurance needed, if any.

$ 319,687

d. List insurance needed, if any, to provide estate liquidity. (This is the case when the total in Step 4 is negative.)

$ 0

e. Add amounts in Steps c. and d. to determine additional amount of insurance needed

$ 319,687

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To Keep or Replace a Policy

Factors to Consider• Health issues• New acquisition costs• Existing policy values• New contestable and

suicide clause period• Dividends in new

policy likely lower• New initial cash value

likely lower

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Question 1

Postmortem expenses typically include all of the following excepta. funeral expenses.b. investment funds.c. last illness expenses.d. estate taxes.

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Question 2

Which of the following does not accurately describe a valid policy replacement scenario?a. Replacing one term policy with another is

usually the least complex of the alternatives.b. Replacing a cash value policy with a similar

cash value policy usually is not advantageous.c. Replacing a cash value policy with a term

policy usually is unwise.d. Replacing a term policy through the policy’s

conversion clause is usually the best and least expensive alternative.

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Question 3

Which of the following are broad economic assumptions (rather than an individual’s personal situation) that must be made during the life insurance selection process? I. the rate of return a client can earn on

investmentsII. the inflation rate for the calculation periodIII. current resources available to purchase

insuranceIV. the client’s risk tolerance

a. I and II onlyb. II and III onlyc. III and IV onlyd. I and IV only

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©2015, college for financial planning, all rights reserved. session 9 life insurance needs...

Documents

total of step

year step

reasonable step

nonliquid assets step

funeral costs step

total liquid assets

total nonliquid assets

total liabilities