LIFE INSURANCE PROBLEMS
Teresa is a single parent that earns $45,000 per year. She estimates that her funeral costs would be $15,000 and would like to set up a college fund for her daughter at $60,000. Teresa would also like her daughter to receive a lump sum upon her death to cover her care for the next 10 years which is estimated at $20,000 a year.
Use the budget approach to recommend the level of life insurance that Teresa needs to purchase? (Show calculation)
Use the income method to calculate Teresa's life insurance needs (Show calculation)
Which method would you recommend using in this situation? Explain your choice and why it would be the best option.
Budget Approach Recommendation
Calculation:
Total expenses Teresa wants to cover:
- Funeral costs: $15,000
- College fund: $60,000
- Daughter's care (10 years): $20,000/year * 10 years = $200,000
- Income replacement percentage: Typically, you'd want to replace 50-75% of Teresa's income to maintain her daughter's standard of living. Let's assume we use 75%.
- Number of years of income replacement: This depends on Teresa's daughter's age and how long she'd financially rely on Teresa. Let's assume 5 years for this example.
- The income replacement approach considers Teresa's income and its impact on her daughter's future financial needs. It ensures there's enough money to cover ongoing expenses, not just one-time costs.
- The budget approach only accounts for specific expenses Teresa identified, but it might not capture all future financial needs the daughter may have.
- Teresa's existing debts (if any)
- Teresa's daughter's age and potential future education costs beyond the $60,000