How Much Term Does Dana Actually Need?
Dana, 38, is a hospital pharmacist earning $85,000; her husband earns $52,000. They have two children, ages 3 and 6, a mortgage balance of $212,000 with 22 years remaining, childcare costs of $14,000 a year, a $120,000 college goal, $31,000 in credit-card and auto debt, and $15,000 earmarked for final expenses. Existing coverage: a $150,000 group term certificate at work (3x salary, terminates at separation), a $25,000 whole life policy, and a $40,000 401(k) balance. The family wants to keep the house and fund college if Dana dies. She asks for $1,000,000 of 20-year term 'because it's a round number.'
1. Build a capital-needs estimate for Dana. Is $1,000,000 of 20-year term defensible, or should the face amount or the term change?
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Compute the need, then compare.
Needs
- Debt to clear: $212,000 mortgage + $31,000 consumer debt = $243,000
- Final expenses: $15,000
- College: $120,000 (in today's dollars; tuition inflation vs. investment return roughly offset if funded over 15 years)
- Income replacement: youngest child is 3, so roughly 16-19 years of dependency. At 65% of her $85,000 income = $55,250/yr, undiscounted for 16 years = ~$884,000; discounted at ~4% ≈ $650,000. A crude 10x-income shortcut gives $850,000. Use a range: $650,000-$850,000.
Gross need: ~$1,028,000 to $1,233,000 Resources: $150,000 group + $25,000 whole life + $40,000 401(k) = $215,000 (only if the 401(k) is genuinely available to survivors) Net need: roughly $815,000 to $1,020,000
Verdict: $1,000,000 lands at the top of a defensible range - the round number happens to be close, but show the work, because the answer swings up or down by $200,000 depending on the income-replacement assumption and whether the 401(k) is counted.
Term: 20 years takes her to 58 and the youngest to 23 - but the mortgage has 22 years left, so the term ends two years short of the largest single obligation. Better: a ladder, e.g., $600,000 for 20 years plus $400,000 for 30 years, to match a declining need and cut cost.
2. Why is the $150,000 group certificate a weaker foundation than $150,000 of individual term? What should Dana ask HR?
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Four structural weaknesses:
- Not owned by her. It ends at separation, retirement, or a move to part-time status, and the employer can change carriers or benefit levels unilaterally.
- Amount is not fixed. It is tied to salary and many schedules step down at older ages - precisely when a death would be least expected but the need has not vanished.
- Tax quirk: employer-paid group term above $50,000 generates imputed income under IRC §79 (Table I) on her W-2, even though the death benefit itself is income-tax-free.
- Conversion is a deadline, not a feature. Group term usually offers conversion to individual permanent coverage only within about 31 days of termination, at attained-age rates, often without evidence of insurability. Miss the window and the right is gone.
Ask HR: Is the certificate convertible, until when, and at what premium basis? Is there a portability option (usually short-duration term) separate from conversion? Does coverage continue during FMLA or disability leave, and who pays? Is supplemental or dependent coverage available at group rates? Get the certificate's conversion provision in writing and calendar the 31-day window now.
3. If Dana dies in year 8, how is the $1,000,000 death benefit taxed? What changes if she names her estate?
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Income tax: nothing. IRC §101(a) excludes death proceeds from the beneficiary's gross income, whether taken as a lump sum or in installments. Only the interest element is taxable if proceeds are left on deposit under an interest-bearing settlement option.
Estate tax: she owns the policy, so §2042 pulls the proceeds into her gross estate as incidents of ownership. Here that is harmless - her total estate is far below the federal exclusion amount, and Wyoming imposes no state estate or inheritance tax. If she wanted the proceeds outside her estate she would need an irrevocable life insurance trust and would have to give up all incidents of ownership; the cost and inflexibility are not justified at this estate size.
Naming the estate changes three real things:
- Proceeds go through probate - delay, public record, and administration fees.
- Proceeds become reachable by estate creditors and by claims against the estate.
- The contingent-beneficiary chain is lost; if the estate is the beneficiary and probate is contested, the family waits.
Named individuals still get the §101(a) exclusion; the loss is procedural and creditor-related, not income tax. Answer should separate the income question from the estate question cleanly - they are commonly conflated.