How much insurance do you need?

Income replacement approach:

Capitalization of lost income

Capitalized value = annual income ÷ rate of return

Impact of investment returns, inflation and income tax

Inflation-adjusted rate of return =[(1 + return)/(1 + inflation rate)]-1

After-tax, after-inflation rate of return = inflation adjusted rate of return × (1 – tax rate)

 

Weaknesses of the income replacement approach

  • fails to address what the survivors actually need

  • fails to address the life insured’s desire to create or protect an estate.

  • how long the lost income would have been generated if the life insured had not died

 

Capital needs approach:

•Income earned by survivors

•Ongoing expenses

1.Increase e.g., childcare.

2.Decrease e.g., food, clothing.

3.Unaffected e.g., home heating.

4.Eliminated entirely e.g., the life insured’s golf membership, or mortgage payments if the mortgage is to be paid off with insurance monies.

 

Table x- Summary of the family’s monthly expenses, current and after death

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