Question

PJ and Meg O’Sullivan Evaluate Their Life Insurance Needs

PJ and Meg O’Sullivan, ages 35 and 30, respectively, are considering the purchase of additional life insurance. They’re both employed full-time, and they have one child who is 10 years old. Meg’s annual after-tax income is $45,000 and PJ’s is $70,000. Currently, Meg has a $20,000 term life insurance policy paid for by her employer, and PJ has a $70,000 individual term life insurance policy. The O’Sullivan’s would like to have enough life insurance on each other so that, in the event of either’s death, it would cover the lost cash flow to the household, help pay off some household debts, and fund their child’s college costs. They have estimated these costs (in present value terms) as follows:

College fund for child                                      $70,000

Pay off existing mortgage on home          $150,000

Pay off credit card balances                         $10,000

Fund immediate costs at death                  $15,000

For the first three years immediately following the death of either Meg or PJ, they do not want their household income to be reduced at all during this re-adjustment period. After that, they will account for the fact that their household expenses and savings (i.e., their entire total household income) will be about 25 percent less if either one of them dies and will remain 25 percent less until their child completes college 12 years from now.

If Meg were to die, the cost of replacing her services to the household would be $10,000 per year for the next 8 years (until the child reaches age 18). If PJ were to die, this annual cost would be $5,000 for the same time period. They don’t anticipate that either of them would qualify for a Social Security benefit due to continued employment, but the child would be eligible for a $1,000 per month benefit until age 18. The O’Sullivan’s currently have about $50,000 in home equity but they do not want to sell their house or incur debt (by taking out a loan against that home equity) if one of them dies. They also have $35,000 in savings that they are ready to use to achieve their overall plan if one of them dies.

The O’Sullivan’s have assumed that the average annual rate of inflation will be 3.5 percent and their long-run average annual investment return will be 9 percent. They have also assumed that neither one of them will require any further assistance from life insurance beyond the time when the child graduates from college (assumed to be at age 22, four years after beginning college at age 18).

Given this information, use the spreadsheet template to determine how much additional life insurance is needed on both Meg’s life and PJ’s life. Set up each person’s needs analysis as a separate tab in the same spreadsheet file and email the file to me as an email attachment. Please be sure to type your name in one of the spreadsheet cells at the top of the spreadsheet or include your name in the name of the file when it is saved.

LIFE INSURANCE NEEDS IF PJ DIES
INCOME & EXPENSE NEEDS:					$ TOTALS:
1. Cash Needed at Death:
a. Funeral, burial, taxes, etc.	>	15,000
b. Pay off debts (immediate)	>	10,000					rate of return =	9%
c. Spouse retirement fund (immediate)	>	35,000					inflation rate =	3.50%
d. Children's college fund (immediate)	>	70,000					real economic rate =	0.055
b. Other needs (immediate)	>	150,000					Interest rates in decimal form
c. TOTAL IMMEDIATE CASH NEEDS =			>		280,000
2. Income Needs (After Taxes):	Readjustment	Pre college	College
a. Monthly after-tax household income	3,750
b. PLUS: Additional monthly expenses/savings needed after death
c. MINUS: After-tax monthly Social Security benefits received	1,000
d. MINUS: Reduced monthly expenses/savings after death
e. MINUS: Spouse monthly after-tax income continuing	3,750
f. MINUS: Monthly after-tax pension/other income received
g. Net after-tax monthly needs (a+b-c-d-e-f)	(1,000)	-	-	-
h. Number of years in period	3	9	4
i. PV of Funds Needed During Period	(33,269)	-	-	-
j. Current PV of Funds Needed	(33,269)	-	-	-
k. PV of TOTAL INCOME NEEDS =					-
3. TOTAL DOLLAR NEEDS (1c + 2k) =			>		280,000
FINANCIAL RESOURCES AVAILABLE:
1. Savings & Investments	>	-
2. Group Life Insurance	>	-
3. Other Life Insurance	>	-
4. Other resources	>	-
5. TOTAL RESOURCES AVAILABLE (1-4) =			>		-
ADDITIONAL LIFE INSURANCE NEEDS =			>>		280,000

Answer 1

Additional Information: