Question

Your friend John asks you for advice concerning life insurance. John is 26 years old and graduated from law school last year. He currently earns $40,000 per year. John’s wife, Mary, is a graphics designer who currently earns $50,000 per year. Mary is 28 years old. The couple have three children: Billy, age1, Cindy, age 3, and Sally, age 5. John and Mary pay $1,000 per month for their home mortgage, which will be paid off in 25 years. The interest rate on their mortgage is 6%. (Their current equity in the home is $30,000.) The couple owns two cars, one is 10 years old and in relatively good condition. The other is new, and their car loan payments are $450 per month for the next 38 months. The interest rate on the car loan is 4%. The couple’s personal property (such as clothes, electronics, furniture, etc.) is valued at $40,000. Their investments include checking, savings, and mutual fund accounts equal to $6,000. John has no life insurance. Mary has a $50,000 whole life insurance policy provided as a fringe benefit from her employer. If John should die, Mary would receive approximately $5,000 per year for each child 18 years of age or younger from Social Security.

John and Mary spend almost all of their take-home pay each month. They are able to save $100 per month that they deposit into a tax-deferred college fund for the children. The college fund has been earning a respectable rate of return of approximately 6.5% per year. The fund balance right now is $5,000. Their other investments earn approximately 5% per year.

John is worried about what may happen to his family is he should die. He is considering the purchase of life insurance and asks your advice. Assuming neither John nor Mary will receive large inheritances, how much life insurance do you think John needs on his life? (Use the needs approach.) Show all calculations and explain your answer. Make any assumptions you believe are reasonable, and make sure your assumptions are clearly stated. Also indicate the type of insurance you would recommend, whole life or term, and explain why.

Answer 1

Answer:

Life Insurance

Calculations

Assuming the following expenses on John’s death

Medical   5000

(1000×12×25=288,000)   Mortgage

The full cost is 300,000 plus their equity of 30,000 bringing it to, 330,000. They also need to pay an interest of 6 on the mortgage which is 19,800

John would thereby leave a debt of 330,000 + 19,800 = 349,800

Estate settlement costs including burial expenses    40,000

Credit card debt                                                         50,000

Car loan ($450 × 38)                                                 17,100

Family needs

Providing for children                                                 750,000

(Current estimates are of the opinion that it costs around 250 000 to raise a child)

Mary’s income needs after retirement                                     100,000

(Considering she has a pension)

We then add all the family needs            1, 306, 900

Assets available

Personal property    40,000

Investments            6,000

Savings   (100×12)       1200

Social security 5,000×(11+15+13)= 195,000

(Since, Billy, age1, Cindy, age 3, and Sally, age 5)

Mary’s life insurance       $50,000

Assets                                                            292.200   

The difference between the needs and the assets is the amount of life insurance John should take which is: 1,014,700

   Since he is a young man I would advise him to take a term policy as it is not only more affordable but with this policy he can able to buy a life policy that will cover his family’s financial obligations including living expenses, children’s education and mortgage. These needs would be covered if he were to die pre maturely.