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Thursday, February 05, 2015

How much Life Insurance Cover do you actually need?

Life is unpredictable. Therefore, Life Insurance is necessary to mitigate the financial risk to your family if something happens to you. Most people do not understand how much cover do they actually need, and that's why they are either under insured (too big a risk to take) or over insured (wasting their money). 
Let us find out how much life insurance cover do we "actually" need...Read on...

The thumb rule
The most intelligent of the people who know how to deal with this subject use a thumb rule to calculate the total insurance need of the earning member. While this is a good starting point to give you a very high level idea of the coverage need, but this can be blatantly far from truth.
The general thumb rule used in the industry is to cover yourself for about 8-10 times your annual income.
So, if you earn Rs. 1 Lacs a month, then you must get insured for 1 Lacs * 12 * 10 = Rs. 1.2 Crores.
This calculation is a good beginning to get an idea about the cover need, but if you are actually going to get insured, don't fall for this trap. 
Because the fact is that your life insurance cover has nothing to do with your income :), simple because the purpose of an insurance cover it to make sure that your 'expenses' and 'liabilities' are taken care of, in case something happens to you...not your 'income'

What all should we include in our calculations:
You better include the following before you actually go in to buy your insurance cover:

(1) Your family's living expenses
You need to make sure that your family is able to survive through the life, while meeting all the living expenses for the remainder of their lives or at least till the children become self independent.
So, if your family expenses are Rs. 30,000/- per month and you are 40 years of age, then you can assume a life span of another 35 years and calculate the total expenses that you would be incurring in the next 35 years. The approximate amount needed to cover your family expenses in this case would be 30,000 * 12 * 35 = 1.26 Crores.

(2) Liabilities / Debts
All your Home Loan, Vehicle Loan, Personal Loan, any credit card outstanding, any loan to be paid back to your relatives or friends - all of these need to be handled by your family via this insurance cover, in your absence. So, if you have a pending home loan outstanding of 40 Lacs and vehicle loan outstanding of 10 Lacs, then you need to take care of another 50 Lacs in your cover.

(3) Special Future Events
Over and above your regular monthly expenses, you will likely have some special future events like your child's marriage, higher studies etc..which needs to be paid via this cover. Lets say you have 2 children, and all the special future events are likely to cost you around 50 Lacs. Include this in your cover need over and above your expenses and liabilities.

(4) Minus existing Assets
Now, also look at your assets and if you have built good enough assets, then you may actually require very less cover. So, total up the current value of all your Public Provident Fund (PPF), Employee Provident Fund (EPF), Fixed Deposits (FDs), Recurring Deposits (RDs), Gold, Stocks, Mutual Funds etc...and subtract this amount from the total of (1) + (2) + (3) above. The reason we are subtracting the assets are simple. The money derived from your assets should anyways be accessible for your family to meet the expenses and debts, assuming you have nominated your family members on each of your assets.
A financially free person like me, actually does not need any insurance cover...another positive of achieving financial freedom :)

Conclusion
While thumb rule does give you a good starting point, Life insurance is a much more serious risk mitigation strategy, which deserves a comprehensive calculation of the need. And the need is very individual for every person, and keeps changing with time.

Do the right calculation, save your money and get the right coverage...



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Cheers

Manoj Arora
Freedom can buy you.... what money cannot !!

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