Once you determine the amount of income that needs to be replaced, you must decide whether the pool of capital to provide this income will be preserved or liquidated.
CAPITAL PRESERVATION:
With this approach, the capital used for income replacement is left intact and the beneficiaries live off the income it produces.
To calculate, arrive at the annual income need, divide this figure by the assumed after tax rate of return (conservative) that can be earned on the income replacement fund.
Pros:
Optimally Provides income stream indefinitely as the principal (death benefit) remains intact
Simple to calculate
Cons:
If the rate of return is lower than the assumed rate, the beneficiaries could run out of money prematurely
The amount of money needed to fund income replacement typically is greater that other methods, as the beneficiaries are intended to live off of income only
CAPITAL LIQUIDATION:
Using this method, the length of time of income needs to be replaced becomes a major factor in determining the capital needed for income replacement.
Pros:
Typically requires less money than the capital preservation method, as both principal and income are used
Cons:
The length of time that the insured's salary needs to be replaced is highly subjective. Requires all the factors mentioned in the worksheet, as well as an examination of human life value
More complex to calculate
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