QUESTION: We're confused by all the different "rules" we have heard and read about for figuring how much insurance I should carry to protect my family property. Is there an easy way?
ANSWER: There is really only one way to figure your insurance needs - and it isn't easy. In addition, it's a very personal problem, unique to you and your family and not solvable by neat general rules.
You and your wife should first sit down and estimate - with as much accuracy as possible - the annual income your wife would need to maintain your family in whatever life stlye you feel would be appropriate after your death.
Then subtract from that amount the total of any regular survivor benefits she would receive from other sources: social security, your employer's retirement plan, etc. Also subtract a conservative estimate of your wife's earnings if she works now or has employable skills and she would continue working.
Next calculate how much capital would be required to produce the remaining amount of annual income. In today's interest market you might want to use an eight per cent yield figure; this is what she could get on a federally insured eight-year certificate of deposit.
(Other fixed-income investments are paying more now, with relative safety, but high-quality stocks, with possible inflation protection, are yielding a little less. Social security and possibly other survivor benefits have built-in cost-of-living escalators.)
Next step: Add to this capital requirement an estimated lumpsum cash amount for "final expenses" - medical/hospital expenses, funeral costs, estate and inheritance taxes, and other expenses of administering your estate. Add some more relocation expenses if you anticipate that your family might move; and another little chunk for living expenses until social security and other benefits start to arrive.
Now you know how large a total estate you must leave for your family. From this total subtract the net realizable value of your present assets - cash, stocks, bonds, real estate, other investments. Count the equity in your home if it is likely that your wife will sell it; but remember to deduct selling expenses and possible income tax liability (on the capital gain) from a conservative selling price.
(Some counselors suggests you include all of your personal assets such as clothing, jewelry, furniture, etc. in your estate inventory. But much of this will not be sold; and the balance will have very little value in a forced sale unless you have some particulary valuable asset like a stamp or coin collection, recognized works or art, or documented antiques that your wife would want to sell.)
Having done all this, you will have an amount that represents the "estate gap" - the number of dollars which must be supplied by insurance in order to create an estate large enough to pay the final expenses and leave enough capital to generate the income needed to support your surviving family.
You can see now why it isn't an easy task. And I haven't even mentioned some of the variables that must be considered. For example, social security benefits are reduced as each child reaches maturity; after the youngest child becomes ineligible, there are no payments to your wife until she reaches age 60. (This is the so-called "widow's blackout.")
This is a job that requires considerable planning and figuring; in addition, it's a job that must be redone at regular intervals, and particularly whenever there is a significant change in either financial or family circumstances.
If you go through all of these steps, you still have taken care of only one of the two major life insurance questions. The second question is "How much life insurance can we afford?"
This is a whole new ball game, involving compromises between insurance and competing family needs or desires, and choices between term and whole life (the two basic kinds of life insurance).
Many men and women evade the whole problem of life insurance - perhaps it forces us to face the fact of our own mortality. But it is absolutely necessary if you want to make proper preparation for the welfare of your family in case you're not around to take care of them in person.
Q: A friend told me that if I own municipal bonds, I can't claim any interest deduction on my tax return. I'm in a tax bracket that makes municipals attractive; but I don't want to lose the substantial tax savings from my mortgage interest.
A: Unfortunately, you didn't get the complete story from your friend. You may not take a tax deduction on Schedule A for interest paid on money borrowed to buy municipal ("tax-free") bonds.
(This restriction also applies to money borrowed to purchase a single-premium insurance of endowment policy; or a single-premium annuity contract purchased after March 1, 1954.)
But ownership of municipal bonds will not disqualify an otherwise legitimate interest deduction for such things as mortgage payments, car loans, or charge accounts.
In spite of the horror stories you might have heard, the IRS does not indulge in the kind of tortured reasoning that might conclude that you should have applied the money spent on tax-free securities to pay off your mortgage instead.
However, they might reasonably infer a connection between non-taxable investment income and deductible interest if you pay for municipal bonds in full, and at the same time pay interest on a margin account at your broker for the purchase of stocks or corporate bonds.
So don't worry about claiming all the normal interest deductions even if you own municipal bonds. But you can anticipate possible IRS concern if you own municipals and also deduct investment-related interest expense.