CASE STUDY

Sam and Jennifer Smith, both aged 35, have three small children. Susan age 10, Sara age 8, and Ana, age 3. The Smiths want to ensure that they have adequate resources in place to complete their estate plans, should Sam pass away prematurely.

Considering their current resources and expressed needs as noted below, what is an appropriate amount of life insurance they should consider?

Needs

• Pay final expenses of $20,000
• Repay credit card debt of $9,000
• Repay mortgage on the family home of $230,000
• Repay car loan of $10,000
• Establish an educational fund of $50,000 for the children
• Charitable bequest of $10,000

Current Resources / Assets

• Cash in savings account of $6,000.
• Group insurance on Teds life of $85,000
• Spousal group insurance on Terris life of $45,000
• If Sam dies, Jennifer will start to work as a teacher and will earn $52,000 per year. She will participate in the teachers pension plan until age 60, at which time her pension will be approximately $23,000 per year.

Objectives

They want to maintain the family income at $85,000 per year while the children are minors, then $65,000 until her retirement at age 60, and $55,000 thereafter. They are assuming Jennifer will live to age 90. For planning purposes, they have chosen to disregard any provisions for government-sponsored benefits arising from premature death and any tax deductions for Jennifer.

Note: To simplify the capital needs analysis, ignore inflation and assume a 5% rate of return can be earned on any monies invested to generate income.

Your Assignment

Assume that Sam has just died. Taking into consideration Smiths current resources and expressed needs, answer each of the following questions and show your calculations, where appropriate.

Questions

1. What is the immediate net cash position after paying final expenses?
2. If they were to also repay their debts and cover other lump-sum needs, how much additional liquid cash would be required?
3. With respect to their long-term income needs, what is the annual income shortfall in each of the periods identified?
4. It has been determined that on average there will be a shortfall of $2,500 per month in ongoing income to meet all the long-term income needs. They do not want to use up any capital, only the earnings on that capital, to cover the shortfall. How much capital would be required to cover this shortfall if they could get an investment return of 5% per year on that capital?
5. Using the information from questions 1, 2 and 4, what is the additional amount of insurance on Sams life that would be required to meet the familys objectives?
6. What type of insurance and in what amounts would you recommend? Provide an explanation to justify each of your recommendations.