Solution Chapter 10 Problem 8

# Solution Chapter 10 Problem 8 - 8 Life Insurance Once again...

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8. Life Insurance Once again, we emphasize the approximate nature of any solution. Your students should have the elements of this suggested solution, but their assumptions will differ. Using the Income Approach: Assume: i) Real rate of return is 3% ii) Rule of thumb tax adjustment is 75%. iii) Added child care expenses equal to reduction in living expenses plus Canada Pension payable to Maria and children on death of Walter. Any other reasonable assumptions by students can be incorporated easily in the solution. All the values are in real dollars. iv) Work to age 65. Insurance on Walter: PV of added stuff at death: lump sum CPP 3,000 Life insurance 62,000 65,000 Note that this is an income replacement approach. The other assets of the family are accumulated from past income. PV required = PVA 31,000 (3%, 35 years) - 65,000 = 666,104 - 65,000 = 601,104. Tax-adjusted = .75 X 601,104 = 450,828. Insurance on Maria: Assume: i) That child care expenses increase by \$3,000 on her death. ii) Walter will have a marginal tax rate of 30% Income shortfall = 4,000 + 3,000 = 7,000. Before tax income required = 10,000 PV required = PVA 10,000 (3%, 36 yrs) = 218,323 Tax-adjusted = .25 X 218,323 = 163,742 . Using the Expense Approach Assumptions: 1

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i) In either death, the mortgage is paid off with some of the insurance proceeds. This is tax- efficient, since mortgage interest is not tax- deductible, but interest on the insurance proceeds is taxable. In addition, it allows us to simplify the calculation of amount G in Table 10.1 to an annuity. The mortgage would be paid
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## This note was uploaded on 10/14/2011 for the course ADMS 3541 taught by Professor Staff during the Winter '10 term at York University.

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Solution Chapter 10 Problem 8 - 8 Life Insurance Once again...

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