WEALTH Matters — FALL 2011

Case Study: LIFE INSURANCE NEEDs ANALYSIS

Even if you don’t have a written financial plan, you probably share three goals with most Canadians:

· Put your kids through college or university,

· Pay off the mortgage on your home, and

· Be able to live comfortably without working past age 60 or 70.

 

You may be surprised to learn that of 100 young men graduating from high school, about 15 of them will die before they reach age 65 (Statistics Canada link) Sadly, the families they leave behind often have to give up on these three common goals (and many others) because they lack the income of the deceased breadwinner.

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YEAR END TAX PLANNING

Case Study—LIFE INSURANCE NEEDS

Interest Rate Trends

Investment Market Commentary

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How much insurance is enough?

That depends a mostly on your age and your income, and your spouse’s age and income.

Household expenses usually don’t decrease by much when a spouse dies. There is one less person to feed and clothe, but property taxes and utilities stay the same, and the children’s education still needs to be paid for. Often, the largest saving occurs because there is one less car. On the other hand, there may be some expenses that go up—more meals out, more babysitting expenses, help may be needed with home maintenance and repairs, etc. On average, there might be a 10% - 20% reduction in total expenses on the death of one spouse.

Household income, on the other hand, decreases by an average of 50% on the death of one spouse. Most households have two working spouses, and if their incomes are roughly equal, then the death of either of them drops total income by 50%. If only one spouse is working, then his or her death would cause a 100% drop in household income, while the death of the non-working spouse would have a 0% impact on income (but will likely increase expenses to replace the unpaid labour in the home).

Fortunately, life insurance can be a very inexpensive way to protect your family’s progress toward your goals. But the Canadian Life and Health Insurance Association reports that almost one third of Canadians have no life insurance at all, and many of those that do likely don’t have enough to allow their families to maintain their standard of living (link). We think that’s rather sad, especially since careful insurance planning may cover all of your needs without costing more than you’re already paying now. The case study below shows how.

 

Term Life Insurance

The goal of most life insurance programs is to replace some or all of the income loss to preserve the standard of living. Therefore, a younger person would need much more insurance because their income would need to be replaced for a longer time. As you get older, there are fewer and fewer years of income from employment left in your forecast, and hopefully your savings are growing, so the financial impact of a death in the family is much less. Fortunately, insurance is cheapest when you are young and have large needs. As those needs decrease, the coverage can be decreased to match the need.

Case Study—Insurance for Bob and Judy

We used a financial model to calculate how much capital that would be needed to fund those income supplements, assuming a reasonable long term rate of return, and also considering the rising cost of living. We see that on Bob’s death, Judy would need $836,000 and on Judy’s death Bob would need $438,000. Most people are surprised at these large numbers.

Bob and Judy already have their mortgage balance life insured through the bank, so this reduces their capital need dollar for dollar. Bob has $160,000 of life insurance through his employer, and Judy has $100,000, so these amounts can also be subtracted from the total need. That leaves Bob with a need for an additional $426,000 of life insurance and Judy would need almost an extra $100,000 on her life.

What about you?

We hope that reading this story has made you think about your own insurance needs.

We would be glad to prepare an analysis like this for you that uses your specific assumptions. It’s wonderful to help our clients achieve their goals, and it’s very sad when unforeseen events prevent our clients from reaching their goals. It’s great to be able to help our clients ensure that their life goals will be achieved even if there is a disability or a death in the family. And because our firm represents all of the major life insurers in Canada, we can be sure we’ll find the best value for you. Please give us a call—we’re here to help!

Solving the Problem

Bob and Judy were surprised that we could cover their total needs calculated above, at a cost of less than $50 per month using a 10-year term life insurance plan (Sun Life, regular health, non-smokers).

They were even more surprised that increasing the coverage amount to replace the bank’s mortgage life insurance added less than $25 per month to the premiums. That’s $60 a month lower than they are already paying for the bank’s mortgage life insurance (link)! They can get all of the additional protection they need, and pay less premiums than they’re paying now.

Bob and Judy are both 40 years old, and own their own home with a $250,000 mortgage to be repaid over 20 years. Bob earns $80,000 a year as a systems analyst, and Judy is a bookkeeper earning $50,000. They have two children aged 3 and 5, for whom they have been contributing to RESPs to fund their future education. They are also investing $1,500 per month into RRSPs to save for their retirement.

In the analysis below, we assume that their cash flow needs would decrease by about 20% on either death. Subtracting the survivor’s net income from this reduced total need shows us the amount needed for income replacement. We assume this need persists until normal retirement age, to allow the remaining family to live a comparable lifestyle with only one income earner, and we assume that the survivor would continue to save what they need to be self-sufficient in retirement. Based on these assumptions, if Bob dies, Judy needs an extra $38,000 per year, and if Judy dies Bob needs an extra $19,000 per year.

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Un-covered Needs Only

Un-covered needs plus mortgage

 

$426,000 T10

$100,000 T10

$676,000 T10

$350,000 T10

Bob

$35.99/month

————

$48.49/month

————

Judy

————

$11.16/month

————

$23.99/month

Insurance Needs Analysis for Bob and Judy

Bob

Judy

Total

Pre-Tax Income

$80,000

$50,000

$130,000

After-Tax Income

$58,000

$39,000

$  97,000

Survivor Income Needed (20% reduction)

$77,500

$77,500

 

Income Supplement Needed to age 65

$19,500

$38,500

 

Capital Required on spouse’s death assuming a 5% investment return and 3% inflation

$438,000

$836,000

 

Less existing personal, group and mortgage ins

-$350,000

$-410,000

 

Insurance needs not presently covered

$88,000

$426,000