Your One-Stop Guide to Ascertaining Your Life Insurance Needs
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21 Aug, 2018
98% of Indian policy holders are under-insured or have an irrelevant type of policy. This is because they buy Life Insurance either to save tax or as an investment. The truth is that Life Insurance is neither about saving tax nor about making an investment. Life Insurance is all about providing for your family and protecting their lifestyle, when you are not around.
Before you panic about being over or under-insured, ask yourself the following question – “In case something happens to me, how much life cover do I have? Is it sufficient to cover all my liabilities, my children’s education, their marriages and my family’s monthly expenses till my children become independent?”
Thus, the question that arises is – So how much Life Insurance do you need and how should you calculate your insurance needs?
Let’s take the example of Harsh Parekh to understand the amount of cover he would require. He is a businessman in his late thirties, living with his wife (a homemaker) and son.
Step 1: One time expenses of your dependents (A)
Clearing off liabilities: Rs. 50 lakh
Corpus for son’s education: Rs. 40 lakh
Corpus for son’s marriage: Rs. 10 lakh
Total one-time expenses: Rs. 1 crore (A)
Step 2: Dependant’s annual recurring expenses (B)
Monthly Expenses: Rs. 50,000
Annual Expenses: Rs. 50,000 *12 = Rs. 6 lakh (B)
Step 3: Survivor’s annual income (C)
Rs. 0 -None (C)
Step 4: B – C = Annual Shortfall (D)
B – C = Rs. 6 lakh – Rs. 0 = Rs. 6 lakh (D)
Step 5: Multiply D by the number of years you expect the youngest dependant or child to become independent and after that till your spouse is of 80 years(E)
Son is 10 years old
Wife is 38 years old
Number of years his son will take to become independent: 12 (till he attains the age of 22)
By then, his wife will be 50, so add an additional 30 years until her age of 80
Total no of years: 12 * 6 lakh = Rs. 72 lakh (son)
30 * 4 lakh (annual income required during wife’s retirement) =Rs. 1.2 crore
Total E = Rs. 72 lakh + Rs. 1.2 crore = Rs. 1.92 crore (E)
Step 6: A+ E = FINANCIAL RISK YOU NEED TO COVER (F)
Rs. 1 crore + Rs. 1.92 crore = Rs. 2.92 crore (F)
Step 7: Total investments and assets that you own (G)
Rs. 1 crore (G)
Step 8: Current life insurance you have (H)
Rs. 20 lakh (H)
Step 9: Additional Cover Required = Financial risk you need to cover (F) – Total investments and assets that you own (G) – Current life insurance you have (H)
Rs. 2.92 crore – Rs. 1 crore – Rs. 20 lakh = Rs. 1.72 crore
Rs. 1.72 crore is the additional cover that Harsh Parekh needs to have, should something happen to him today.
You can use the same method to calculate how much cover you’ll need. Once you have done this, it’s best to go in for a Pure Term Plan. A Term Plan is the simplest and cheapest form of life insurance and one that has no maturity value. While there are many insurance policies in the market a Term Plan serves the purpose of life insurance – to ensure your loved ones are secure in your absence. A Term Plan provides the policy-holder with protection only. If the policy-holder dies within the specified number of years (the term, say 20 years), his nominee gets the sum insured. If he lives beyond the specified period, the policy-holder gets nothing.
Thus, instead of opting for various Insurance Policies and ULIPs, buy a Term Plan and investing the rest in Mutual Funds depending on your tolerance to risk and investment time frame. Check out our post “Where to invest- ULIPs versus Mutual Funds?” to evaluate the best option for you.
Lastly, remember that Insurance and Investment decisions should be taken in the context of your overall financial life. While you may not have the time or the expertise to this, consulting a trusted financial planner is a good way to get started.