23 Steve is married to Katie and currently earns $7,000 per month before taxes. If he dies, he wants Katie to continue to receive the same income. Calculate the amount of life insurance coverage Steve will need assuming a rate of return of 6%, using the income replacement approach and ignoring inflation. a. $2,000,000 b. $1,400,000 c. $1,000,000 d. $1,600,000See answer
Daftar Isi
23 Steve is married to Katie and currently earns 7000 per month before taxes If he dies he wants Katie to continue to receive the same income Calculate the amount of life insurance coverage Steve will…
Question
23 Steve is married to Katie and currently earns $7,000 per month before taxes. If he dies, he wants Katie to continue to receive the same income. Calculate the amount of life insurance coverage Steve will need assuming a rate of return of 6%, using the income replacement approach and ignoring inflation. a. $2,000,000 b. $1,400,000 c. $1,000,000 d. $1,600,000
Super Answer
Let’s solve this step by step to determine the required life insurance coverage using the income replacement approach.
Step 1: Identify Known Information
- Monthly Income: $7,000
- Annual Income: $7,000 × 12 = $84,000
- Rate of Return: 6% per year
- Goal: Maintain same income indefinitely
- Using perpetuity formula: Principal = Annual Payment ÷ Interest Rate
Step 2: Apply Perpetuity Formula
- Principal needed = Annual Income ÷ Interest Rate
- Principal = $84,000 ÷ 0.06
- Principal = $1,400,000
Step 3: Check Answer Options
- $2,000,000 (too high)
- $1,400,000 (matches our calculation)
- $1,000,000 (too low)
- $1,600,000 (too high)
Final Answer
The correct amount of life insurance needed is $1,400,000 (option b).
This amount, when invested at 6%, will generate 7,000 monthly) in perpetuity, maintaining Katie’s current standard of living. The calculation uses the perpetuity formula since we want the income to continue indefinitely and are ignoring inflation.