by Archie M. Richards, Jr., CFP^®
March 7, 2005

Eric, 35 years old, is planning how much life insurance he needs to protect his family against his death. His wife, June, is 33. They have a daughter (8) and son (5).

Eric makes $45,000 a year. Working at home, June makes $10,000. They have $65,000 in qualified retirement plans.

Assuming Eric died today, June would need $20,000 for immediate expenses, $150,000 to repay the mortgage and $10,000 to repay other debts. Total: $180,000.

For the college education of the two children, the parents are willing to pay $15,000 a year in today's dollars. Escalation for inflation is needed.

Eric and June are libertarians. They believe that if the federal government stopped supporting education and professor tenure were terminated (making faculties subject to the forces of supply and demand confronted by everyone else), the cost of higher education would go down, not up. But they acknowledge that these changes won't occur soon. They therefore estimate that the college costs for the two children will grow at 3 percent a year.

Their daughter will attend college from the 10th to the 13th year in the future (4 years total). Increasing $15,000 by 3 percent a year to the 13th year raises the annual costs to $22,000 a year. For 4 years, this comes to $88,000. To be conservative, Eric assumes that the $88,000 is needed in the 10th, rather than the 13th year.

The son will attend college from the 13th to the 16th year. Increasing $15,000 by 3 percent a year to the 16th year raises the annual costs to $24,000 a year. For 4 years, this comes to $96,000. To be conservative, Eric assumes that the $96,000 is needed in the 10th year - the year the older child begins college.

$88,000 and $96,000 total $184,000 - the amount needed for college education 10 years in the future. How much is needed now to provide for this?

Eric and June observe that government economic policies are improving and free markets are increasingly being allowed to operate throughout the world. They believe that freedom is on the march, helping everyone. They also observe that stupendous technological advances are approaching. For all these reasons, they believe that investments in the stocks of the world will appreciate by at least 10 percent a year. They also expect U.S. income tax rates to continue falling. They therefore assume that funds invested in a diversity of investment sectors (with at least 60 percent in stocks - half in the U.S.) will grow on an after-tax basis at 8 percent per year.

How much is needed now, growing at 8 percent a year for 10 years, to attain $184,000 for the college education of the two children? Using an inexpensive financial calculator, Eric determines that the amount needed today is $85,000.

Finally, June feels comfortable receiving $30,000 a year, in addition to her employment. The capital needed now, at 5 percent, to supply this income is $600,000. ($30,000 divided by 0.05). The $600,000 is also assumed to grow at 8 percent a year. If June withdraws only 5 percent, the value of the portfolio (and its income) should increase.

Okay, the amounts needed are $180,000 + $85,000 + $600,000, for a grand total of $865,000. Eric and June already have $65,000 in qualified retirement plans. They therefore need $800,000 of life insurance.

According to Intelliquote (www.intelliquote.com), a 35-year-old, non-smoking male in good health (we'll assume a resident of Kansas) can buy an $800,000, 20-year term, insurance policy for $37 a month - not much money for a whole lot of life insurance.

Eric and June should also set aside an additional 10 percent of their pay in investments, with as much as possible in tax qualified vehicles, such as 509 education plans, 401(k) plans, and IRAs.

Let's say that 20 years hence, at age 55, Eric remains alive and well, and the mortgage and college costs are paid off. Less insurance will be needed. $500,000 of 10-year term insurance would then cost under $100 a month.

After 30 years, investments will fill all their needs, making life insurance unnecessary.