Special Exercise 3 Life Insurance & Retirement Needs Exercise RMI 3500 – Fall 2007 – Klein Part I: Life Insurance Needs (Required) The correct answers to this section are based on the set of facts and tables provided below. All the data you need to perform the necessary calculations are contained in the tables following the three paragraphs below. Show all your calculations so you can receive partial credit even if you make a mistake. Ralph and Alice are married and have a daughter, Morticia, age 8. Alice, age 27, earns $40,000 annually from her job. Ralph, age 30, earns $50,000 annually from his job. Assume that Ralph will die before Alice. The family wants to ensure that they have adequate life insurance on Ralph to cover their cash and income needs if Ralph dies. Hence, they want to determine if they should purchase additional life insurance on Ralph to cover these needs. The tables below provide figures on their: 1) cash needs; 2) present insurance and financial assets; 3) income needs; and 4) income that the family will receive if no additional life insurance is purchased. Use the figures in these tables to determine how much, if any, additional life insurance the family should purchase on Ralph to cover their needs. In your answer, calculate and show the components of any additional life insurance needed in terms of cash needs and income needs and the total amount of additional life insurance needed. This exercise assumes that: 1) Ralph dies immediately; 2) Alice continues to work if Ralph dies; 3) OASDI survivor benefits are only payable to the daughter until she is age 18; and 4) the life insurance proceeds are invested at an interest rate equal to the rate of inflation. Cash Needs: estate clearance mortgage redemption emergency fund educational fund
$15,000 $150,000 $20,000 $100,000
Present Insurance and Financial Assets: group life insurance $150,000 investments/savings $10,000 Income Needs: readjustment period dependency period blackout period Alice’s retirement period
$5,000 monthly for 2 years $5,000 monthly for 8 years $3,500 monthly for 28 years $3,000 monthly for 25 years
Expected Income from Sources Other than Life Insurance: readjustment period $3,500 monthly for 2 years dependency period $3,500 monthly for 8 years blackout period $3,000 monthly for 28 years Alice’s retirement period $2,000 monthly for 25 years
1
2
Part II: Retirement Income Needs (Optional) Carmen needs to determine how much she will need to save to meet her retirement income objectives. Assume that Carmen is age 40, has yearly earnings of $50,000 and anticipates receiving raises of 5% per year. Also, Carmen plans to retire at age 65 and will need 70% of her pre-retirement income to meet her retirement income needs. Assume that Social Security will cover 25% of her pre-retirement salary and her employer’s plan will cover 40% of her preretirement salary. Also assume that Carmen will be able to purchase an annuity when she retires that will cost $1,000 per $100 of yearly income and that she will receive a 7% interest rate on her savings. Calculate how much Carmen will need to save (annually and in total) in order to purchase an annuity that will cover the gap between her retirement income needs and what she will receive from Social Security and her employer’s plan.
3