In yesterday’s post, “How Much Life Insurance Is Needed For Capital Retention” I shared with you the formula for calculating how much life insurance you need if your goal is to replace your income for your spouse’s lifetime.
The Capital Retention strategy is excellent if your goal is to replace your income for an uncertain amount of time, like your spouse’s lifetime. However, the Capital Retention strategy typically requires more insurance than the average American has.
In today’s post I want to share two methods for using the Capital Depletion strategy. It is used if your goal is only to provide enough cash to replace your income for a certain number of years. It is an ideal strategy if your goal is only to replace your income to your family while the children are still “dependents” or until your spouse is old enough to qualify for Social Security Retirement benefits.
The nice thing about the CAPITAL DEPLETION strategy is that it is significantly less costly. If you elect to use the CAPITAL DEPLETION strategy, you will not need nearly as much life insurance and the need of hiring an attorney to draw up a Trust is not as great. If your plan is set up correctly, and your beneficiary is correctly educated on what to do, there would be no reason to hire an attorney, unless you just want one.
The bad thing about the CAPITAL DEPLETION strategy is that when your heirs get their monthly income payments, that payment is made up of both the original amount of the tax-free life insurance benefits and taxable interest.
At the end of the payout period, nothing will be left in the account.
METHODS OF CALCULATING
There are two ways of calculating how much cash (life insurance and savings) your heirs would need, if you elect the CAPITAL DEPLETION strategy for replacing your income after you die.
If you are comfortable with math, and your heirs would prefer to use some form of fixed interest investment/savings account, the formula in the graphic above will help you determine how much life insurance you want.
If you are not comfortable with math and would prefer your life insurance company to do everything for your heirs, tell your insurance professional you want to look at the Death Benefit Annuity chart for your life insurance company. You will find that chart in your policy. Since you do not have your policy, at this time, ask your insurance professional to get you a sample policy so that you can see the chart.
On that chart you will find benefit payout options. Look at the chart that gives you payouts for Periods Certain. (Be aware that each insurance company may use different language but the concept is in that policy somewhere.)
Pick the factor that most closely meets your needs and apply it to the amount of income you want to replace.
The result is the amount of term life insurance you should consider.
If you are going to use this strategy, remember that it is mathematically precise. If your loved ones use any of the death benefits from you life insurance, to pay things like funeral or final medical bills, this strategy will not work.
In the first post in this series about setting up a life insurance portfolio, “Life Insurance: Not How Much But What Type,” I recommended people to have a separate Whole Life/Final Expense plan, in addition to your Term Life, to pay for those bills.
That way, your loved ones will not have to invade the Term Life plan in order to pay bills