Advanced Diploma of Financial Planning (ADFP) Practice Test

What approach determines the life insurance needed based on the desired annual income for the family?

1. Capital accumulation approach

2. Capital retention approach

3. Income replacement approach

4. Investment growth approach

The correct answer is: Capital retention approach

The approach that accurately assesses the life insurance coverage needed based on the desired annual income for the family is the income replacement approach. This method focuses on ensuring that the family can maintain their standard of living after the loss of the primary income earner. It calculates how much life insurance is required to replace the income that would have been earned over time, factoring in inflation and the number of years until retirement or other potential end-of-income scenarios. The capital accumulation approach, on the other hand, emphasizes accumulating a certain amount of savings or capital that could generate income in the future, rather than directly replacing the lost income. The capital retention approach aims at preserving existing capital and ensuring it lasts over time, without a direct emphasis on income replacement, while the investment growth approach focuses on enhancing the value of investments rather than managing income loss due to untimely death. Therefore, the income replacement approach stands out as the most relevant method for determining the appropriate amount of life insurance based on the family's need for income continuity.