Question

In: Finance

Michelle is the breadwinner her family. Michelle is married to Daniel. They are both 30 years...

Michelle is the breadwinner her family. Michelle is married to Daniel. They are both 30 years of age. They have two children ages 3. Michelle earns $80,000 per year. She has a $100,000 life insurance policy with her employer. They have $10,000 in debt and $200,000 in mortgage debt. Daniel would like to return to work at some point as a teacher where he earns $50,000 per year. They are both covered under the social security system. Both children expect to attend college at $20,000 per year. Michelle wants to know what things to take into consideration when identifying how much life insurance is needed. She doesn’t need a specific number, but rather a detailed explanation and the steps needed to take to complete the calculation. They have $150 per month to purchase life insurance and would also like to know what type and length of insurance they need.

Solutions

Expert Solution

As a rule of thumb, DIME formula is used to come to a life insurance requirement. DIME stands for debt, income, mortgage and education.

This formula doesn't incorporate the already existing insurance and savings. Thus, these numbers need to be subracted from the number arrived using the DIME Formula.

Debt and final expenses: Debts + mortgage + funeral expense (Optional)

Income: On the basis of how many years the family would need support, multiply the annual income by that number. The multiplier can generally be the number of years left before the youngest child graduates from high school (~ 15 years for Michelle).This can be used to calculate the income replacement needs.

Mortgage: Amount needed to pay off mortgage.

Education: Cost of education (~$100,000 per child)

Target coverage amount = (annual salary * number of years for income replacement) + mortgage balance + other debts + Child education + Funeral Costs - (savings + existing college funds + current life insurance)

Additionally, in Michelles case, as Daniel is currently stay-at-home parent, one must also include the cost to replace the services that Daniel provide, such as child care.

Term life insurance suits Michellle's case as she has a young family and/or a mortgage and is looking for the most affordable option, considering she has only a budget of $150/month. Additionally, it is also renewable and provides some flexible options in the future. the length of the insurance should be for at least 20 -25 years, considering they have a yound family to support and the children are just 3.


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