Needs Analysis, Policy Design, and Naming Minor Children as Beneficiaries
A 38-year-old married father earns $120,000; his wife earns $40,000. They have children ages 4 and 7, a $320,000 mortgage, $60,000 in savings, $180,000 in a 401(k), and $150,000 of group term life on him. They want to replace 70% of his income for 15 years if he dies, pay off the mortgage, fund $240,000 of education, and cover $20,000 of final expenses. Assume no investment return and that the wife's income continues. They are considering a $1.5 million 20-year term policy and naming the children as primary beneficiaries.
1. Compute the capital need and the coverage gap under the stated assumptions.
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Income replacement: $120,000 x 70% = $84,000 per year x 15 years = $1,260,000. Add the mortgage $320,000, education $240,000, and final expenses $20,000. Total capital need = $1,840,000.
Resources: savings $60,000 + group term $150,000 = $210,000. The $180,000 401(k) should generally be excluded because it is retirement money the surviving spouse will need later. Gap = $1,840,000 - $210,000 = $1,630,000. A $1.5 million policy leaves a $130,000 shortfall unless the 401(k) is spent, which is not prudent. If the 401(k) were counted, the gap would be $1,450,000, which shows why the treatment of retirement assets must be stated explicitly.
2. Evaluate the proposed policy type, amount, and duration.
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A 20-year level term policy matches the 15-year income-replacement need and covers the 14 years until the youngest child reaches 18. The amount should be about $1.63 million, not $1.5 million. A laddered approach may be better: a larger 20-year policy for the income and education need plus a smaller 25- or 30-year policy for the mortgage tail. The policy should include a conversion privilege and waiver of premium or disability income protection. The wife's income and the need for coverage on her should also be reviewed. Term is appropriate because the need is temporary and the budget is better spent on adequate death benefit than on cash value.
3. Explain the beneficiary designation problem and the ownership and estate issues.
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Minor children cannot receive life insurance proceeds directly. If they are primary beneficiaries, a court will likely appoint a guardian or conservator, creating delay, expense, and limited control over how the money is used. A better approach is a trust for the children's benefit or a UTMA custodial arrangement, with a responsible trustee or custodian and a contingent beneficiary. The designation should specify per stirpes or per capita treatment and should be reviewed after divorce, remarriage, or additional children.
Ownership also matters. If the insured owns the policy and the estate is the beneficiary, the proceeds may be included in his gross estate. Having the wife own the policy, or using an irrevocable life insurance trust, can avoid estate inclusion, but the insured should not retain incidents of ownership. The client should coordinate beneficiary, ownership, and will or trust documents rather than treating the application as a formality.