In the event of an untimely death, survivors may be left without the household income needed to sustain their lifestyle. Life insurance coverage is recommended in an amount that will ensure sufficient ongoing income, as well as cover immediate needs, such as final expenses.
Determining proper levels of life insurance involves a comparison of current and future household expense levels with expected surviving spouse’s earnings plus survivor benefits. Other resources are also taken into account such as liquid assets, investments, pension, and retirement accounts.
Insurance needs estimates are the calculated lump sum amounts which would provide a source of future cash flow to supplement the anticipated household income.
The report determines the present value of the anticipated expense and the present value of income sources, to determine any survivor need shortage in today’s dollars. The present value calculation uses the “Discount rate for survivor needs NPV calculation” entered in the rates section.
Present Value of Spending Needs
– Present Value of Income Sources
= Net Estimated Survivor Need Shortage
After determine any survivor needs shortage in today’s dollars, the report then factors in current liabilities and investments. Existing life insurance coverage will be included as a resource to offset shortages. The result will be the surviving households uncovered shortfall in today’s dollars, presented as suggested additional life insurance coverage.
Net Estimated Survivor Need Shortage
+ Currently Existing Liabilities
– Assets Available to Offset Shortage
+ Current Life Insurance Coverage
= Suggested Additional Life Insurance Coverage
Present Value of Spending Needs
The “Anticipated Spending Needs” represents the amount the surviving household would need today to cover spending from now until the final year of the projection.
The spending needs are based on the amount entered for “Annual current expenses for a surviving household now” and “Annual expenses for a survivor in retirement.” The amounts will increase using the inflation rate to the right of the expense amount.
A year-by-year view of the survivors spending need is shown on the Survivor Needs Calculation. The present value of the spending needs is shown above the column header, which matches the “Anticipated Spending Needs” shown on the Survivor Needs Analysis report.
In this example, the “Annual current expenses for a surviving household now” of $80,000 is shown, increasing by 3% a year. Upon the survivor reaching retirement, the expense amount changes to the “Annual expenses for a survivor in retirement” increasing at the corresponding 3% inflation rate. The present value of the spending need from now until the final year of the projection amounts to $2,087,540.
The Survivor Needs Calculation report includes a year-by-year breakdown of education costs. The present value of the education costs is included above the column header.
Final expenses represent a three-month cushion for spending. This amount equals a quarter of the client’s amount entered under “Current annual expenses.” This final expenses amount representing a spending cushion is an assumption built into the program and cannot be changed. In this example, “Current annual expenses” are $90,000, resulting in a final expense amount of $22,500.
This amount will be included in year one of the “Other Inc/Exp” column on the Survivor Needs Calculation. If there are any special income or expenses occurring year one, the net amount will display under this column.
Other expenses includes items entered under the “Special Expense/Goal” input. Special expenses amounts will be included the “Other Inc/Exp” column on the Survivor Needs Calculation.
Add items (1) through (4) to arrive at the present value of the total need for the surviving household. This includes spending needs, education expenses, final expenses, and other expenses/goals. This is the total amount needed in today’s dollars to cover spending and expenses from now until the final year of the projection for the surviving household. This amount displays in black, representing the total spending need.
Present Value of Income Sources
If the surviving spouse is employed, his or her earned income and associated increase rate, entered under the “Income/Pension/SS” section, is assumed to continue in a survivor situation from current age until the retirement age. The income is reduced for taxes using the pre-retirement tax rate.
The Survivor Needs Calculation includes the year-by-year projection of earned income. In this example, Mary as the survivor will continue to earn $78,000 increasing by 2% until her retirement age of 36. With a pre-retirement tax rate of 25% in this case, Mary’s after-tax income amounts to $58,500. The present value of Mary’s after-tax employment income is included above the column header, amounting to $744,120.
The program will calculate Social Security benefits for the surviving household. The amount will include benefits for the surviving spouse starting at age 60, or for earlier age periods if there are depended children in the household. The report will display the after-tax amount, assuming 85% of the benefit is taxable.
See the Survivor Needs Calculation for the annual breakdown. In this example, there are dependents which is why Social Security benefits are included in the current year until the last child reaches 18. Benefits began again for the surviving spouse at age 60. The present value of available Social Security income is included above the column header, amounting to $553,785, matching the amount shown on the Survivor Needs Analysis.
Pension benefits will include any personal pension benefits at the set starting age and amount, after taxes. Additionally, any survivors pension benefits available to the surviving spouse will be included, starting at the current age and going until life expectancy after taxes.
Review the Survivor Needs Calculation for the year-by-year projection of the pension amounts available to the survivor. The amounts will be reduced for taxes, using the pre-retirement rate until retirement age, then using the post-retirement rate.
Other income includes any item entered under the “Special Income” input. Special income amounts will be included the “Other Inc/Exp” column on the Survivor Needs Calculation.
Add items (6) through (9) to arrive at the present value of the total income available for the surviving household. This includes the after-tax income from employment, Social Security, pensions, and special income items. This is the total amount of income available in today’s dollars from now until the final year of the projection for the surviving household. This amount displays in red, representing the total income available to help offset spending.
Net Estimated Survivor Need Shortage
The difference between present value of spending needs (5) and the present value of income sources (10) is the “Net Estimated Survivor Needs Shortage.” The amount the surviving household’s spending needs exceeds income sources will display in black.
In this example, the surviving household has a total need for spending and expenses of $2,263,712 (5) and total income sources available to offset the spending need of $1,297,905 (10). The differences is a $965,807 shortfall (11).
The projection will factor in the balance of current liabilities. This will add to the insurance need, ensuring the surviving household has enough funds to pay off existing debt.
The current investment balance is included as a source available to offset the surviving household’s needs. This only includes investment assets (savings/retirement plans/annuities etc.) and does not include any personal assets such as a residence.
14. Current Life Insurance Coverage
If there is current life insurance coverage, the death benefit will be included as a source to offset the surviving household’s needs. The option to control if the death benefit is available for the survivor reports is found on the insurance input per policy. Checking the box, “Include Policy Death Benefit in Insured’s Survivor Needs Analysis” will ensure the death benefit is included.
Suggested Additional Life Insurance Coverage
The suggested additional life insurance coverage is the difference between the net estimated survivor need shortage (11) plus liabilities (12), less current assets (13) and current insurance coverage (14). This represents the additional amount needed in today’s dollars to offset any remaining survivor needs shortage after accounting for current debts, assets and insurance benefits.
In this example case, the net estimated survivor need shortage of $965,807, plus the balance of current liabilities of $240,000, less the balance of current investments of $526,000, less the current life insurance coverage of $250,000 amounts to a remaining shortfall of $429,807. The remaining shortfall is the amount of suggested additional life insurance.