Continuing Case: Cory and Tisha Dumont
Protecting yourself with insurance
Using the earnings multiple approach would result in the following life insurance calculations for Cory and Tisha. Cory’s needs
= $38,000 x (1 – 0.22) x 12.46 = $369,314
= $46,000 x (1 – 0.22) x 12.46 = $447,065
Cory currently has $76,000 (2 x $38,000) of term life insurance through his employer. Consequently, Cory should consider purchasing approximately $293,000 of additional life insurance coverage. Tisha has $69,000 of term insurance through her employer, as well as a whole life policy of $50,000. She should consider purchasing an additional $328,000 of life insurance coverage ($447,065 – $119,000). While Tisha or Cory would continue to earn their salaries, if widowed, and would receive some Social Security benefits, they would experience a significant reduction in their standard of living without adequate life insurance.
The Dumonts, and Cory in particular, take a big risk when their life insurance is entirely in the hands of their employers. If Cory or Tisha leave their jobs, their group term coverage ends. However, they may be able to convert the group coverage to an individual policy. Since the Dumonts need additional life insurance, they should purchase individual policies to supplement the coverage they have. This will reduce the risk of later becoming uninsurable or, if they were to lose their jobs, having no life insurance at all.
At their stage in the life cycle, term insurance is the best option for the Dumonts. It provides the greatest amount of insurance per premium dollar. Universal and variable life policies both include cash value components, through earnings from interest or mutual funds, respectively, which increase the cost of insurance coverage. These policies also tend to have high insurance, investment and administrative expenses, which add to their cost. The option to skip the premium payment on universal life or a variable universal life may prove too tempting, as it does for many policyholders, who subsequently let the policy lapse. The Dumonts would be well advised to purchase affordable term insurance and do their saving/investing outside of their insurance policies.
The life insurance policy features that should be explained to the Dumonts include: Type of policy: term or cash value. The Dumonts’ policies provided at work are group term insurance policies available for the duration of their employment. Tisha also has a whole life policy (cash value insurance) with $1,800 of accumulated cash value. Nonforfeiture clause (on Tisha's whole life policy): options for receiving a policy's cash value, a paid-up whole life policy with a reduced face value, or a paid-up term policy with the original policy face amount in exchange for ending the policy. The Dumonts could exercise this right if they are unable to pay the annual premiums to continue the coverage for an extended period of time. Beneficiary designation: persons named as primary and contingent beneficiaries to receive the death benefits from the policy. Coverage grace period: automatic extension, usually 30 to 31 days after a premium payment is due, before a policy lapses. The premium may be paid without penalty. Loan clause: (on Tisha's whole life policy) describes procedures and the interest rate charged for borrowing against the policy's cash value. Suicide clause: clause stating that the face amount of the policy will not be paid for a suicide death within 2 years of the purchase of a policy. Incontestability clause: clause stating that the insurance company cannot dispute the validity of a contract after it has been in force for a specific period, usually 2 years. Settlement options: section that describes alternative ways that the beneficiaries of a life insurance policy can choose to receive death benefits. Riders: special provisions added to a policy that either provide extra...
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