Sue and Tom Wright are assistant professors at the local university. They each take home about $42,000 per year after taxes. Sue is 37 years of age, and Tom is 35. Their two children, Mike and Karen, are 11 and 9.
Were either one to die, they estimate that the remaining family members would need about 75% of the present combined take-home pay to retain their current standard of living while the children are still dependent. This does not include an extra $400/month in child-care expenses that would be required in a single-parent household. They estimate that survivors' benefits would total about $1,200 per month in child support.
Both Tom and Sue are knowledgeable investors. In the past, average after-tax returns on their investment portfolio have exceeded the rate of inflation by about 3%.
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 calculations.
Suppose the Wrights found that both Tom 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?
SHOW ALL WORK FOR EACH ASSIGNMENT AND EXPLAIN EACH STEP CAREFULLY.
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To determine how much the Wrights would need in the family maintenance fund if Sue were to die today, we will use the "needs approach." This approach considers the family's current standard of living and calculates the amount required to maintain that standard in the event of a death.
Step 1: Calculate the annual take-home pay needed to maintain the current standard of living.
The remaining family members would need 75% of the present combined take-home pay. Let's calculate this:
Annual take-home pay needed = 75% of $42,000 (combined take-home pay)
Annual take-home pay needed = 0.75 * $42,000 = $31,500
Step 2: Adjust for the additional child-care expenses required in a single-parent household.
An extra $400 per month in child-care expenses would be required, which totals $400 * 12 = $4,800 per year.
Adjusted annual take-home pay needed = $31,500 + $4,800 = $36,300
Step 3: Calculate the annual survivors' benefits (child support).
The Wrights estimate the survivors' benefits to total about $1,200 per month, which equals $1,200 * 12 = $14,400 per year.
Step 4: Calculate the gap between the required take-home pay and the survivors' benefits.
Gap = Adjusted annual take-home pay needed - Annual survivors' benefits
Gap = $36,300 - $14,400 = $21,900
Step 5: Calculate the size of the family maintenance fund needed.
To calculate the family maintenance fund, we use the concept of the "time factor." It is the number of years the funds are needed to bridge the gap until the children are no longer dependent.
In this case, we will assume the children will become financially independent at the age of 18, so the time factor is 18 - 11 = 7 years (Mike's age when the need arises).
Family maintenance fund needed = Gap * Time factor
Family maintenance fund needed = $21,900 * 7 = $153,300
Therefore, if Sue Wright were to die today, the Wrights would need approximately $153,300 in the family maintenance fund to maintain their current standard of living until the children are financially independent.
Now let's proceed with the steps the Wrights should follow to close the $50,000 life insurance protection gap.
Step 1: Determine the amount of existing life insurance coverage.
The Wrights should identify their current life insurance policies and determine the amount of coverage they already have in place. This may include any policies provided through their employer or policies they have purchased individually.
Step 2: Calculate the remaining gap to be closed.
Remaining gap = Protection gap - Existing life insurance coverage
Remaining gap = $50,000 - (amount of existing coverage)
Step 3: Assess the available options for closing the remaining gap.
The Wrights should explore different life insurance options, such as term life insurance or permanent life insurance (including whole life or universal life), to find the most suitable solution for their needs. They can consult with insurance agents or financial advisors to understand the features, benefits, and costs of each option.
Step 4: Obtain quotes and compare policies.
The Wrights should request quotes from multiple insurance providers for the coverage they determined in the previous steps. They should compare the premiums, policy terms, and coverage amounts to identify the most affordable and suitable option for closing the remaining gap.
Step 5: Apply for the selected life insurance policy.
Once the Wrights have decided on a specific life insurance policy, they must complete the application process. This typically involves providing personal information, undergoing a medical examination (if required), and submitting any supporting documents requested by the insurer.
Step 6: Review and finalize the policy.
After the insurance provider processes the application, the Wrights should carefully review the policy terms and conditions, including the coverage amount, premium payments, and any exclusions or limitations. If satisfied, they can proceed to finalize the policy by signing the necessary documents and submitting the initial premium payment.
Following these steps will help the Wrights search for protection to close their $50,000 life insurance protection gap in a systematic and informed manner.