Life Insurance Needs: Capital Retention Approach
What is the capital retention approach?
The capital retention approach is one of two methods of calculating
your family's life insurance needs under the family needs approach. It is not
an independent approach. Rather, it is one of two ways to determine the lump
sum of insurance proceeds the surviving spouse will need to receive and invest
in order to take care of ongoing family income needs. Under this approach, you estimate
the necessary lump-sum amount assuming that you will be preserving insurance
proceeds while providing income during the readjustment, dependency, blackout,
and retirement periods. This way, you make sure that resources are still
available to generate income should the surviving spouse outlive his or her
life expectancy. Moreover, you preserve capital to be passed on to heirs when
the surviving spouse dies.
Under the alternative capital liquidation approach, you don't
provide for continued capital availability for either supporting the surviving
spouse indefinitely or inheritance by heirs after the spouse's death. You get
the advantage, though, of spending less on life insurance, since you require a
smaller amount of life insurance proceeds at the insured's death.
Why choose the capital retention approach?
You should focus on capital retention when using the family needs
approach if you want to preserve life insurance proceeds, attend to ongoing
income needs strictly through interest earned, provide income to the surviving
spouse indefinitely in case the spouse outlives his or her life expectancy, and
provide assets for the heirs to inherit. It is the more conservative of the two
approaches. While offering your family some extra security, it also means that
you must purchase more life insurance than under the alternative capital
liquidation approach.
Strengths
Less risky approach than capital
liquidation
The capital retention approach guarantees that some or all of the
insurance proceeds will remain available to support the surviving spouse if the
spouse significantly outlives his or her life expectancy.
Better approach for heirs
This approach enables your family to preserve capital in the form of
insurance proceeds to pass to heirs after the surviving spouse dies.
Tradeoffs
Requires spending more on life
insurance than does the capital liquidation approach
To retain capital beyond the surviving spouse's remaining life
expectancy, you will need to spend more on life insurance than you would with
the capital liquidation approach.
How to use the capital retention approach
Generally speaking, the family needs approach requires you to make
the following calculations in order to estimate life insurance needs:
• Immediate needs at death
• Ongoing family income needs
• Expected other income sources
The following equation yields an estimate of the insurance you need:
Immediate needs at death
+ Ongoing family income needs
- Expected
other income sources
= Family needs
Your choice of the capital retention approach versus the capital
liquidation approach affects your figures for the insurance amount necessary to
cover the ongoing family income needs. If you choose capital retention as
opposed to capital liquidation, you will require more insurance proceeds to
invest in order to cover the ongoing family income needs.
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IMPORTANT DISCLOSURES
The
information presented here is not specific to any individual's personal
circumstances.
To the extent
that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties
that may be imposed by law. Each taxpayer should seek independent advice from a
tax professional based on his or her individual circumstances.
These
materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable—we
cannot assure the accuracy or completeness of these materials. The information
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