1. ©2015, College for Financial Planning, all rights reserved. Session 9 Life Insurance Needs Calculations Policy Replacement Decisions CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Financial Planning Process & Insurance

2. Session Details Module6 Chapter(s)2 & 4 LOs6-2 & 6-5 Analyze a client’s financial situation and goals to calculate the amount of life insurance needed under either the annuity or interest- only method. Evaluate factors that might influence the decision to keep or replace a policy. 9-2

3. 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

4. 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

5. Life Insurance Needs Determination Worksheet Step 1 Gather information from the client. Step 2 Estimate fair market value of assets owned. AssetsFair Market Value Liquid$34,000 Total Liquid Assets$34,000 Nonliquid$12,500 Total Nonliquid Assets$12,500 9-5

6. Life Insurance Needs Determination Worksheet Step 3 Determine liabilities to be paid off if client dies. LiabilitiesAmount $20,000 Total Liabilities$20,000 Estimate postmortem expenses. Postmortem expenses$4,000 Total postmortem expenses$4,000 Total of Step 3$24,000 9-6

7. Life Insurance Needs Determination Worksheet Step 4 Determine liquid assets remaining, if any, after subtracting estimated liabilities and postmortem expenses. Total liquid assets$34,000 Subtract estimated liabilities and postmortem expenses (Step 3) ($24,000) Total of Step 4$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

8. 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 after- tax earnings of spouse $950 Expected monthly Social Security benefits 0 Other monthly benefits 0 Total of Step b.$950 c. Step a. minus Step b.$2,100 9-8

9. 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

10. 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 Life Insurance Needs Determination Worksheet 9-10

11. 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 $ 22,051 Total amount needed in Step 6$ 22,051* *only Susan is included. 9-11

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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.) $ 0 e. Add amounts in Steps c. and d. to determine additional amount of insurance needed $ 319,687 9-17

18. 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

19. 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

20. 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

21. 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

22. ©2015, College for Financial Planning, all rights reserved. Session 9 End of Slides CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Financial Planning Process & Insurance