The McDonalds Want to Know How Much Is Enough Jacob and Emma McDonald are a two-income couple in their early 30s. They have two children, ages 6 and 3. Jacob’s monthly take-home pay is $3,600, and Emma’s is $4,200. The McDonalds feel that, because they’re a two-income family, they both should have adequate life insurance coverage. Accordingly, they are now trying to decide how much life insurance each one of them needs. To begin with, they’d like to set up an education fund for their children in the amount of $120,000 to provide college funds of $15,000 a year—in today’s dollars—for 4 years for each child. Moreover, if either spouse should die, they want the surviving spouse to have the funds to pay off all outstanding debts, including the $210,000 mortgage on their house. They estimate that they have $25,000 in consumer installment loans and credit cards. They also project that if either of them dies, the other probably will be left with about $10,000 in final estate and burial expenses. Regarding their annual income needs, Jacob and Emma both feel strongly that each should have enough insurance to replace her or his respective current income level until the youngest child turns 18 (a period of 15 years). Although neither Jacob nor Emma would be eligible for Social Security survivor’s benefits because they both intend to continue working, both children would qualify in the (combined) amount of around $1,800 a month. The McDonalds have amassed about $75,000 in investments, and they have a decreasing term life policy on each other in the amount of $100,000, which could be used to partially pay off the mortgage. Jacob also has an $80,000 group policy at work and Emma a $100,000 group policy.
Critical Thinking Questions
1. Assume that Jacob’s gross annual income is $54,000 and Emma’s is $64,000. Their insurance agent has given them a multiple earnings table showing that the earnings multiple to replace 75% of their lost earnings is 8.7 for Jacob and 7.4 for Emma. Use this approach to find the amount of life insurance each should have if they want to replace 75% of their lost earnings.
2. Use Worksheet 8.1 to find the additional insurance needed on both Jacob’s and Emma’s lives. (Because Jacob and Emma hold secure, well-paying jobs, both agree that they won’t need any additional help once the kids are grown; both also agree that they’ll have plenty of income from Social Security and company pension benefits to take care of themselves in retirement. Thus, when preparing the worksheet, assume “funding needs” of zero in Periods 2 and 3.)
3. Is there a difference in your answers to Questions 1 and 2? If so, why? Which number do you think is more indicative of the McDonalds’ life insurance needs? Using the amounts computed in Question 2 (employing the needs approach), what kind of life insurance policy would you recommend for Jacob? For Emma? Briefly explain your answers.
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