John, 38, makes $125,000 per year. He has a 35 year old wife, Nancy, and a daughter who just turned 7. John’s share of the family’s consumption is 21%, and he pays an average tax rate of 28%. He plans to work another 30 years and expects salary increases equal to inflation, which he expects to be 3% annually. He expects to earn an 8% nominal rate of return on his investments.
In the event of John’s death,SocialSecurity will contribute $20,000per year to his family while his daughter is 16 or younger (10 years) and $10,000 per year while his daughter is 17 & 18 (2 years). The family will need total income equal to the Family’s Share of Earnings (FSE) until the empty nest period begins, at which point the family’s annual funding needs will decrease by $12,000. Nancy will require $64,000 in annual total income during retirement beginning at age 66. She will receive $20,000 in annual retirement benefits from Social Security and expects to live until age 85 (20 years of retirement). Finally, the family has $75,000 in liquid assets and lump sum funding needs of $182,500.
Assume that John’s daughter’s college education is already being funded from the FSE and therefore does not need to be explicitly considered in the analysis.
Assume all monetary figures above are quoted in real terms, i.e. today’s dollars.
Calculate the amount of life insurance coverage John needs according to the Financial Needs Method. Show your work.