CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Financial Planning Process & Insurance
Session 9
Life Insurance Needs Calculations
Policy Replacement Decisions
©2015, College for Financial Planning, all rights reserved.
Session Details
Module
6
Chapter(s) 2 & 4
LOs
6-2
6-5
Analyze a client’s financial situation and goals
to calculate the amount of life insurance
needed under either the annuity or interestonly method.
Evaluate factors that might influence the
decision to keep or replace a policy.
9-2
The Winn Family Story
Rodney Winn is 38 and married to Margaret, who is 36 (Step 8). Their
children are Jacob, age 17, and Susan, age 15 (Step 5, Step 7). All family
members are in good health. The children plan to attend the local state
university for $6,000 per year (Step 6). They will begin college at 18 and
end when they are 22 (Step 6).
Rodney’s monthly take-home pay is $2,100 (Step 5); as a receptionist,
Margaret’s monthly take-home pay is $950 (Step 5). They describe
themselves as having a low risk tolerance:
• Their net worth is $175,000.
• They have $34,000 in liquid assets (Step 1, Step 4), which is well above
the recommended three months’ emergency fund to cover fixed and
variable expenses.
• Their nonliquid assets (Step 2) total $12,500.
• They have approximately $20,000 (Step 3, Step 4) in liabilities.
• They move $6,500 into savings annually.
Margaret would most likely liquidate the majority of assets in the event of
Rodney’s death.
9-3
The Winn Family Story
continued
Rodney has a $25,000 group term life insurance policy and the family
has adequate health and major medical coverage, making a last-illness
fund unnecessary. They expect $4,000 will cover minimal estate transfer
and funeral costs (Step 3, Step 4). They’re not counting on Social
Security to be available in the near future for their age category, so they
want Social Security, death, and retirement benefits to be ignored.
They feel an after-tax return on their investments of 7% is reasonable
(Step 5, Step 6, Step 7, Step 8) and that inflation will average 5% (Step
5, Step 6, Step 7, Step 8) over the long run.
Margaret wants to maintain her current lifestyle through retirement if
something were to happen to Rodney. Her needs will be substantially
reduced after the children complete college.
The Winns project that after the kids leave home, Margaret’s income
needs will be half of their current income needs ($36,600 ÷ 2 =
$18,300 [Step 7, Step 8]). They expect half of this amount to be
provided by Margaret’s pension plan retirement benefits when she turns
65. At retirement, Margaret wants to have a guaranteed lifetime income
for herself.
9-4
Life Insurance Needs Determination Worksheet
Step 1
Gather information from the client.
Step 2
Estimate fair market value of assets owned.
Assets
Liquid
Fair Market Value
$34,000
Total Liquid Assets
Nonliquid
Total Nonliquid Assets
$34,000
$12,500
$12,500
9-5
Life Insurance Needs Determination Worksheet
Step 3
Determine liabilities to be paid off if client dies.
Liabilities
Amount
$20,000
Total Liabilities
$20,000
Estimate postmortem expenses.
Postmortem expenses
$4,000
Total postmortem expenses
Total of Step 3
$4,000
$24,000
9-6
Life Insurance Needs Determination Worksheet
Step 4
Determine liquid assets remaining, if any, after subtracting
estimated liabilities and postmortem expenses.
Total liquid assets
Subtract estimated liabilities and
postmortem expenses
(Step 3)
Total of Step 4
$34,000
($24,000)
$10,000
If the TOTAL is greater than zero, the amount represents remaining
liquid assets after total liabilities and postmortem expenses are paid. If
the TOTAL is less than zero, the amount represents the amount of
insurance needed for estate liquidity.
9-7
Life Insurance Needs Determination Worksheet
Step 5 – Dependency Period
for youngest child, age 15 until age 18
Estimate funds needed to provide all dependents with income until
youngest child reaches age 18.
a. Desired monthly income
$3,050
b. Expected monthly aftertax earnings of spouse
$950
Expected monthly Social
Security benefits
0
Other monthly benefits
0
Total of Step b.
c. Step a. minus Step b.
$950
$2,100
9-8
Life Insurance Needs Determination Worksheet
Step 5
continued
d. Multiply by 12 to arrive
at annual total payment
$25,200
e. Serial payment
calculation:
3 number of periods
5 % inflation
7 % after-tax yield
Calculate present value of
annuity due (PVAD)
Total Amount Needed in Step 5
$74,196
9-9
Life Insurance Needs Determination Worksheet
Step 6 – Education Costs
Child: Susan
Annual college costs (current)
$ 6,000
a. Inflation adjustment calculation:
3 number of periods until child begins college
5 % inflation
Inflated future value of first year’s tuition
$6,946
b. Serial payment calculation:
4 number of years in college
5 % inflation
7 % after-tax yield
9-10
Life Insurance Needs Determination Worksheet
Step 6
continued
Calculate present value of
annuity due (PVAD)
$ 27,014
c. Discount calculation:
3 number of periods until
student begins college
7 % interest/yield
Calculate the present
value of the above PVAD
Total amount needed in Step 6
$ 22,051
$ 22,051*
*only Susan is included.
9-11
Life Insurance Needs Determination Worksheet
Step 7- Blackout Period
for age 39 until age 65
Estimate preretirement income fund for spouse after youngest child
reaches age 18.
a. Desired annual income for surviving spouse
$ 18,300
b. Expected annual after-tax earnings and
benefits of spouse
$ 11,400
c. Subtract Step b. from Step a.
$ 6,900
d. Serial Payment Adjustment
Inflation calculation:
3 number of periods until serial payments begin
5 % inflation rate
Calculate the future value of the needed
income when serial payments begin
$ 7,988
9-12
Life Insurance Needs Determination Worksheet
Step 7
continued
Serial payment calculation:
26 number of periods between date when youngest
child reaches age 18 and retirement
5 % inflation rate
7 % interest/yield
Calculate PV of annuity due (PVAD)
$ 165,699
Discount calculation:
3 number of periods until serial payments begin
7 % interest/yield
Calculate the present value of the above PVAD
Total amount needed in Step 7
$135,260
9-13
Life Insurance Needs Determination Worksheet
Step 8-Retirement
for age 65 until age 85
Estimate retirement income fund for spouse.
a. Desired annual income for surviving
spouse at retirement
$ 18,300
b. Expected Social Security, retirement or
other benefits of spouse
$ 9,150
c. Subtract Step b. from Step a.
$ 9,150
d. Serial payment adjustment
inflation calculation:
29 number of periods until retirement
5 % inflation rate
Calculate the future value of the needed income
$ 37,663
9-14
Life Insurance Needs Determination Worksheet
Step 8
continued
Serial payment calculation:
20 number of periods of retirement income
5 % inflation rate
7 % interest/yield
Calculate PV of annuity due (PVAD)
$ 633,381
Discount calculation:
29 number of periods until retirement
7 % interest/yield
Calculate the present value of the above PVAD
Total amount needed in Step 8
$ 89,030
9-15
Life Insurance Needs Determination Worksheet
Step 9
Estimate the amount needed for an emergency fund
(supplied for this example).
$ 9,150
Step 10
Determine insurance needs (summary).
a. Add amounts determined by:
Step 5
$ 74,196
Step 6
$ 22,051
Step 7
$135,260
Step 8
$ 89,030
Step 9
$
9,150
Total financial needs
$ 329,687*
*With Jacob’s $22,899 for education the answers are identical.
9-16
Life Insurance Needs Determination Worksheet
Step 10
continued
b. Total resources available (remaining
liquid assets from Step 4)
$ 10,000
c. Subtract total resources available in Step b. from
the total actual needs in Step a. to determine
insurance needed, if any.
$ 319,687
d. List insurance needed, if any, to provide estate
liquidity. (This is the case when the total in Step
4 is negative.)
$
e. Add amounts in Steps c. and d. to determine
additional amount of insurance needed.
$ 319,687
0
9-17
To Keep or Replace a Policy
Factors to Consider
• Health issues
• New acquisition costs
• Existing policy values
• New contestable and
suicide clause period
• Dividends in new
policy likely lower
• New initial cash value
likely lower
9-18
Question 1
Postmortem expenses typically include all of the
following except
a. funeral expenses.
b. investment funds.
c. last illness expenses.
d. estate taxes.
9-19
Question 2
Which of the following does not accurately describe a
valid policy replacement scenario?
a. Replacing one term policy with another is usually the
least complex of the alternatives.
b. Replacing a cash value policy with a similar cash
value policy usually is not advantageous.
c. Replacing a cash value policy with a term policy
usually is unwise.
d. Replacing a term policy through the policy’s
conversion clause is usually the best and least
expensive alternative.
9-20
Question 3
Which of the following are broad economic assumptions
(rather than an individual’s personal situation) that must
be made during the life insurance selection process?
I. the rate of return a client can earn on investments
II. the inflation rate for the calculation period
III. current resources available to purchase insurance
IV. the client’s risk tolerance
a. I and II only
b. II and III only
c. III and IV only
d. I and IV only
9-21
CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Financial Planning Process & Insurance
Session 9
End of Slides
©2015, College for Financial Planning, all rights reserved.