How Much Life Insurance Does a Family Need?

Jim and Kim Cuttner are 40 years old and have one son, age 10. Jim is the primary earner, making $65,000 per year. Kim does not currently work. The Cuttners have decided to use the needs-based approach to calculate the value of a life insurance policy that would provide for Kim and their son in the event of Jims death.

	The Cuttners Needs
Final expenses	They estimate that final expenses (such as funeral costs and estate taxes) would be $10,000.
Income replacement	The Cuttners are cautious and decided to replace Jims income for 25 years, when Kim will be 65. Assume that Kim would invest the life insurance proceeds at a 3% after-tax, after-inflation rate of return. Even though Kim would be eligible to receive survivors benefits when she reaches the age of and then Social Security retirement benefits years later, they want an extra cushion.
Readjustment period	Before the birth of their son, Kim worked as a mechanical engineer, but her knowledge and skills are now somewhat outdated. Therefore, the Cuttners will include $20,000 for Kim to go back to school.
Debt repayment	The Cuttners have home improvements totalling $150,000 and a credit card balance of $1,800. They have 17 years left on the mortgage on their home, but they have provided for its payment with Jims replaced income.
College expenses	A college education at the local public university costs $25,000 today. They will use this figure in the needs assessment with the understanding that Kim would invest the insurance proceeds.

	The Cuttners Existing Assets and Government Benefits
Government benefits	The family would qualify for $3,800 monthly Social Security survivors benefits until the son is years old. Assume that Kim will invest the benefits at a 3% after-tax, after-inflation rate of return. Pay attention to the length of time the son will be eligible for benefits and compute your answer based on how long he will be eligible for those benefits.
Existing assets	There is equity in the Cuttners home, as well as balances in their 401(k)s that they do not want to have to rely on for the familys support if Jim dies. There is currently no life insurance on Jims life.

Using this information and the following table, complete the worksheet to determine how much Jim should insure his life for. Round your answers to the nearest dollar. Enter zero (0) in any rows for which there is no figure. For Social Security survivors benefits or allowance for any current insurance or assets, enter the dollar amount without a minus sign (although you will need to subtract these values from the subtotal when calculating life insurance needs).

Present Value of an Annuity Table

Interest FactorsPresent Value of an Annuity
Years	2%	3%	4%	5%
4	3.8077	3.7171	3.6299	3.5460
5	4.7135	4.5797	4.4518	4.3295
6	5.6014	5.4172	5.2421	5.0757
7	6.4720	6.2303	6.0021	5.7864
8	7.3255	7.0197	6.7327	6.4632
9	8.1622	7.7861	7.4353	7.1078
10	8.9826	8.5302	8.1109	7.7217
11	9.7868	9.2526	8.7605	8.3064
12	10.5753	9.9540	9.3851	8.8633
13	11.3484	10.6350	9.9856	9.3936
14	12.1062	11.2961	10.5631	9.8986
15	12.8493	11.9379	11.1184	10.3797
16	13.5777	12.5611	11.6523	10.8378
17	14.2919	13.1661	12.1657	11.2741
18	14.9920	13.7535	12.6593	11.6896
19	15.6785	14.3238	13.1339	12.0853
20	16.3514	14.8775	13.5903	12.4622
21	17.0112	15.4150	14.0292	12.8212
22	17.6580	15.9369	14.4511	13.1630
23	18.2922	16.4436	14.8568	13.4886
24	18.9139	16.9355	15.2470	13.7986
25	19.5235	17.4131	15.6221	14.0939
26	20.1210	17.8768	15.9828	14.3752
27	20.7069	18.3270	16.3296	14.6430
28	21.2813	18.7641	16.6631	14.8981
29	21.8444	19.1885	16.9837	15.1411
30	22.3965	19.6004	17.2920	15.3725
40	27.3555	23.1148	19.7928	17.1591

Based on GARMAN/FORGUE. Personal Finance, 11E. 2012 South-Western, a part of Cengage Learning, Inc.

	Factors Affecting Need	The Cuttners Figures
1.	Final-expense needs	$
	Includes funeral, burial, travel, and other items of expense just prior to and after death
2.	Income-replacement needs
	Multiply 75%* of annual income by the interest factor from the present value of an annuity table that corresponds to the number of years that the income is to be replaced and the assumed after-tax, after-inflation rate of return.
3.	Readjustment-period needs
	To cover employment interruptions and possible education expenses for surviving spouse and dependents
4.	Debt-repayment needs
	Provides repayment of short-term and installment debt, including home improvements and a credit card balance
5.	College-expense needs
	To provide a fund to help meet college expenses of dependents
6.	Other special needs
7.	Subtotal (combined effects of items 16)	$
8.	Less: Government benefits
	Present value of Social Security survivors benefits and other benefits
	Multiply monthly benefit estimate by 12, and use the present value of an annuity table for the number of years that benefits will be received and the same interest rate that was used in item 2.
9.	Less: Current insurance assets
10.	Life insurance needs	$

*75% is used because about 25% of income is used for personal needs.