Getting adequately covered is also not easy as there is no single formula for evaluation of the amount of life insurance coverage one needs. The standard practice of financial advisors, however, is being used to determine the life insurance coverage through certain thumb rules which are a very often, a rudimentary method is 10-12 times of your annual incomes. But we do not advocate on these types of thumb rules for estimation of life insurance requirements.
Imagine Real Life Scenario
We should be rational one and would have to forget all thumb rules and insurance agents and sit down to figure out how much insurance you need/want. Imagine that what it would be like financially if you or your spouse died and there was no insurance. Imagine that what you would like things to be like financially, and calculate how much insurance is necessary to fill the gap. Another approach is to pick specific insurance amounts and then apply those amounts to your situation. For instance, if you had Rs50 lakh of insurance and you died tomorrow, what would your spouse do with the said money and what would their financial life be like?
So, the first consideration is how long should my term be? For parents, you should get a term long enough that the children you plan to have are independent before the term expires. Otherwise, it’s about your own comfort level. Shorter terms tend to have cheaper monthly premiums, but if you aren’t careful with your money, you may find yourself buying a new, more expensive policy in ten or twenty years.
The next one – and it’s often the big one – is how much? I think there are three key steps to consider.
First Step is what’s the income shortfall for the people left behind? Simply put, how much money each year would your survivors need to maintain their standard of living? This isn’t just straight replacing your salary, since they won’t have your costs any more.
Second Step is, how long will they need that income shortfall? If you have young children, it will be quite a while. If you just have a spouse, they may not need it for as long. You should talk this over carefully with your spouse so that you both can make a realistic decision. I usually encourage people to calculate for their children’s needs until age twenty or so.
Additional things to consider: your own funeral expenses, the cost of college for your children, any wealth you would like left for your children, and the cost of future first house needs, if any.
Third and final step is, how much do you have now? What’s in your savings? Your investments like your existing insurance policies, savings and fixed deposits and most probably, existing mutual investments etc.?
Now, the calculation is simple. Figure up the first number in the first step, multiply it by the second number in the second step, and then subtract the third number in the final step. That’s how much life insurance you should have, in a thumbnail sketch.
If you’re unsure about certain numbers – it is better to avail financial planner’s services that could help on these jargons.
Don’t run over on details. It doesn’t matter how accurate your estimate is because things will change and then you’ll be over- or under-insured. Being a professional financial planner, I did a case study on myself only a couple of years ago where I went through the process for determining how much life insurance I needed. Things have changed so much in the last two years for me, I can’t believe how much that I’ll have revisit this calculation: We have two kids now, our debt is less than half of what it used to be, and I don’t think I’ll keep my day job as long as I’d originally thought. I get a lot of my insurance through work.
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