Sue and Tom Wright are assistant professors at the local university. They each take home about $40,000 per year after taxes. Suye is 37 years of age, and tome is 35. Their two children,Mike and Karen are 13 and 11.
Were either one to die, they estimate that the remaining family members would need about 75% of the present combined tak home pay to retain their current standard of living while the children are still dependent. This does not include an extra $50/month in child-care expenses that would be required in a sigle-parent household. They estimate that surviviors' benefits would total about $1,000 per month in child support.
Both Tom and Sue are knowledeable investors. In the past, average after-tax returns on their investment portfolio have exceeded the rate of inflation by about 3%.
1. If Sue Wright was to die today, how much would the Wrights need in the family maintenance fund? Use the "needs approach" and Explain the reasons behind your calculation.
2. Suppose the Wrights found that both Tome and Sue had a life insurance protection gap of $50,000. Present the steps in sequence how Wrights should proceed to search for protection to close that gap?
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1. To calculate the amount needed in the family maintenance fund if Sue Wright were to die today, we will use the "needs approach" which considers the ongoing financial needs of the remaining family members.
Step 1: Calculate the annual income needed for the surviving family members. According to the information provided, the Wrights estimate that they would need about 75% of their present combined take-home pay to maintain their current standard of living. Therefore, the annual income needed would be:
Annual income needed = 75% * (Sue's take-home pay + Tom's take-home pay) = 0.75 * ($40,000 + $40,000) = $60,000
Step 2: Adjust the annual income needed for inflation and the time period until the children are independent. Since Sue is currently 37 years old and the children are 13 and 11 years old, we need to estimate the number of years until the children are financially independent. Let's assume the children become financially independent at the age of 25.
Time period until children are independent = 25 - 13 = 12 years (approximately)
To adjust for inflation, we can use the historical after-tax returns on their investment portfolio, which have exceeded inflation by about 3%. Let's assume the inflation rate is 2% annually.
Adjusted annual income needed = Annual income needed * (1 + inflation rate)^time period until children are independent
= $60,000 * (1 + 0.02)^12
= $60,000 * (1.02)^12
= $76,226 (approximately)
Therefore, if Sue Wright were to die today, the Wrights would need approximately $76,226 in the family maintenance fund to retain their current standard of living while the children are still dependent.
2. To close the life insurance protection gap of $50,000 for both Tom and Sue Wright, the Wrights should proceed with the following steps:
Step 1: Assess the existing life insurance coverage. Determine the current life insurance policies and their coverage amounts for both Tom and Sue. Calculate the total coverage provided by the existing policies.
Step 2: Compare the existing life insurance coverage with the desired coverage. Calculate the difference between the desired coverage amount (in this case, $50,000) and the coverage provided by the existing policies for both Tom and Sue. This difference represents the protection gap.
Step 3: Research insurance providers and policies. Shop around and obtain quotes from various insurance providers to find policies that can close the protection gap. Consider factors such as coverage amount, premium costs, policy duration, and any additional benefits or riders.
Step 4: Evaluate the coverage options. Review the quotes and policy details received from various insurance providers. Consider factors such as the financial stability and reputation of the insurance company, policy exclusions, and any limitations or restrictions.
Step 5: Select the most suitable insurance policy. Compare the policy options based on the coverage provided, premium costs, and other relevant factors. Choose the policy that best meets the Wrights' needs and budget, taking into account the desired coverage amount of $50,000 for both Tom and Sue.
Step 6: Apply for the selected insurance policies. Complete the required paperwork and provide any necessary documentation to apply for the chosen insurance policies. Ensure that all application forms are accurately filled out.
Step 7: Undergo the necessary medical examinations, if required. Some insurance policies may require a medical examination to assess the applicants' health conditions. Follow the instructions provided by the insurance provider and schedule the examinations accordingly.
Step 8: Review and sign the insurance policy contracts. Once the insurance provider approves the applications, carefully review the policy contracts. Understand the terms and conditions, as well as any exclusions or limitations. Sign the contracts if satisfied with the terms.
Step 9: Pay the insurance premiums. Set up a method for premium payments, whether it is through automatic deductions, online payments, or any other preferred method. Ensure that the premiums are paid on time to maintain the coverage.
Step 10: Monitor and review the insurance coverage periodically. Regularly review the insurance policies to ensure they continue to meet the Wrights' needs. Consider adjusting the coverage as necessary due to changes in financial circumstances, such as an increase in income or the birth of additional children.