As a Navy helicopter pilot, I have witnessed the unfortunate loss of a loved one by too many young families. The pain of sudden death is overwhelming. Our hearts and minds seem to lack the capacity to comprehend the magnitude of such a loss. Time can heal all wounds, but it is excruciatingly slow to heal the wounds of untimely death. This is especially acute when the lost people are young and leave behind families who depended on them.

Life insurance can minimize the financial strain of premature death. It can help provide stability and keep a family in their home, in the same school district, and around their friends and community. These stabilizing influences in the face of such a destabilizing event can help families heal over time.

But how much insurance do we need to protect our families? Without delving into the different methodologies that focus either on an analysis of capital needs or on the economic value of the insured’s life, I wish to propose a simpler and more flexible methodology. It’s the one we planners use all the time. And it’s the one that’s particularly suited to the possibility of premature death, because it matches the necessary inflation-adjusted income to the actual expenses of the loved ones protected. As I would tell investment advisors I have worked with, a death benefit is a portfolio of income distribution waiting to happen.

Let’s detail some of the questions this approach can raise.

Why do we protect for the rest of the spouse’s life? When a family loses one parent, the surviving spouse must effectively become both parents. The emotional charge is effectively doubled. The surviving spouse now has emotionally traumatized children to nurture, as well as the parents of the deceased spouse. Do we want the surviving spouse to also work full time? I think we would all agree that we would want to plan to give our surviving spouse all the resources they need.

Why are we not repaying all the debt? First and foremost, as a planner and business owner, I want to protect cash flow. Paying off a debt in this situation is not always the best decision.

Paying off an expensive car loan is okay, but paying off the mortgage on a family home may not be. The effective mortgage interest rate can be lowered by accelerating payments. We still get a mortgage interest deduction if we itemize. We may reduce the finance cost of lending on a monthly basis until arbitrage can realistically be achieved by reallocating assets – for example, to preserve our income distribution portfolio. Is the current mortgage rate low compared to the current trend?

Finally, my mortgage payment is fixed. My income allocation portfolio tracks inflation. We can gradually pay off the mortgage as we gain space through our growing income distribution. I’m not saying paying for the house is a bad idea; I just don’t want to siphon off assets from an income distribution portfolio.

If we are going to use an income distribution portfolio, how are we going to solve it? The math can be simple. We can provide an estimate of our revenue needs based on our actual and anticipated expenses. We can add accumulation objectives such as investing in the education of children or ensuring that the family can go on annual vacation, if these were not already budget items.

Above all, we may be talking about a super long distribution portfolio. We have to think carefully when deciding on a withdrawal rate. The best research I’ve seen on very long-term income distribution portfolios is The Optimal Withdrawal Strategy for Retirement Income Portfolios by David Blanchett, Maciej Kowara, and Peng Chen.

It suggests a withdrawal rate of 2.7% to start with, then adjusts for inflation going forward. So if you need $50,000 in after-tax income, for example, you’ll need about $60,000 in pre-tax income assuming an average of 20% combined federal, state, and local taxes. Divide the $60,000 revenue stream by 2.7% and you get $2,222,222. Remember that the death benefit from our life insurance is exempt from income tax, but the income distribution portfolio we manage from it is not. If the amount of insurance is too large as we age, we may reduce the death benefit along the way.

It seems logical to employ widely accepted and proven methodologies where they apply. In my opinion, an income distribution portfolio designed for retirement would be very similar to what our loved ones would experience over time following the loss of a parent. What are your thoughts?