How much really you need insurance on your life …
Enough to cover. Ten times your annual
income – these are the interpretations generally financial experts suggest for
insurance. Then what is ‘enough’? How to calculate it? When going for
insurance, what basic points you need to take into account. Let us explore the
matter.
If you are asked whether you have life
insurance policies, instantaneously you will say “Oh ! I have four or five of
them”. In fact only a few people analyse whether they do have sufficient life
coverage. Generally people go in for insurance for getting Income Tax rebate or
just to satisfy a friend’s suggestion or pressure exerted by somebody. For
getting sufficient financial protection to the loved ones in the event of
happening of an unfortunate incident, as a person owning such responsibility,
one will have go in for adequate insurance. The sum assured in a life insurance
policy depends upon a number of factors. Age, annual income, number of
dependents, expenditure, housing and vehicle loans, other loans, savings,
investments, way of life, amounts needed for future contingencies – when such
of these numerous facts are taken into account, then only one gets clarity as
to how much life insurance to be bought.
Right approach for assessment of Insurance
When a person wants to know about the
quantum of life insurance, financial consultants say that it should be 8 to 10
times the annual income. In a way, it may be correct, but it will not be
applicable to all situations. No need for youth to go in for bigger insurance
policies, when they do not have dependents, but at the same time, they have to
foresee the needed educational expenses, expenses for advancement in life,
which are usually heavy and also to cover some undesirable happenings.
Nobody can compensate for the mental agony
that parents undergo, but one can atleast partially replenish it with financial
support to them. It is always advisable to get life insurance equal to 8 to 10
times the annual income, right from the moment when one starts earning.
Financial standings and needs of life
differ from individual to individual. Generally, people wish to know the amount
of premium they can bear before they take insurance. It may be OK for the
present, but when a real need arises in future, it may not be that useful. To
meet such unforeseen contingencies also one has to make up his mind for
planning now itself. For this there are some scientific methods.
Insurance in tune with income…
In this method, insurance depends on the present annual
income. Simple equation for this is… Total insurance = Annual Income x Number
of years of future service.
For example, a person is aged 35 years. He still has 23
years to retire. Annual income is
Rs.3 lakhs. On this basis, he needs insurance of
Rs.69,00,000 i.e., Rs.3, 00,000 x 23.
*
There is another method for calculating the amount of insurance basing on
income:
At least, it should be 10 times the annual income. This
principle also varies with age.
For age range 20 - 30, it would be 5 to 10 times; range 30 to 40, it would be 15 to 20 times;
range 40 to 50, 10 to 15 times and for age range 50 – 60, 5 to 10 times their
annual income. In addition to the income, the future liabilities on account of
housing and vehicle loans, personal loans and other liabilities also are also to
be taken into account for arriving at the sum assured of insurance.
Insurance
basing on the value of life…
Life is life, its value cannot be measured in terms of
money, but then who will take the responsibility for future needs of dear ones?
So, a value should be set to life and every individual has a value expressed in
financial terms. Some methods are there to work out it. Important among them to
be taken into account are – anticipated future income, expenditure to meet the
family related future responsibilities.
For example…
Ramu is aged 40 years. He retires on attaining 60 years.
His present annual salary is
Rs.3, 50,000. His personal expenditure , Income Tax, Life
Insurance Premium and miscellaneous expenses total up to Rs.1,25,00. So, he
still has a balance of Rs.2, 25,000 for his family and so we can say his annual
value is Rs.2, 25,000.
Suppose, something bad happens at his 41st
year of age; his family will be left in a lurch and do not have any income to
live on. Keeping such events in view, how much insurance Ramu should have
taken? Let us calculate.
We know that his family is getting Rs.2, 25,000 out of
Ramu’s total earnings. It means that the
amount the family gets in 20 years is Rs.45, 00,000. Actually this is the total
accumulated value at the end of 20 years. Now we have to arrive at its present value.
If the presumed rate of interest is 8%, its present value would be Rs.23, 85,
000.
What about Insurance Premium?
Amounts we have calculated are big, but what about the
premium to be paid? Presently insurance companies are offering ‘Term Insurance’
policies, where one can get high sum assured with small premium. It is
available even in the net. It is possible to get around Rs.1 crore policy for a
premium less than Rs.10, 000for a person aged less than 30 years. Enough if he
spares atleast 3% of his annual earnings, he gets perfect family protection in
case some unexpected eventuality happens. Two or three lakhs insurance seem
big, but note that they do not meet the future contingency needs.
One
more important point..
Expenses and responsibilities go on multiplying with the
passage of time. Review your insurance needs every three years, basing on them.
Essentiality
in meeting necessities…
Before going in for insurance, review yourneeds and responsibilities
and assess the quantum of insurance you really need to have. In this context,
make a note of the following points.
1.
Responsibilities: What level of standard of living your family wish to
follow? Children’s education, their marriages, provision for financial
protection to parents and other routine and unexpected expenses will have a
bearing on your responsibilities.
2.
Existing need of money: Repayments for housing, vehicle and education
loans and for creation of an emergency fund.
3.
Monthly expenses: Total monthly expenses for the family. House Rent,
monthly provisions, children’s expenses come under this head.
If spouse also is an earning member, take into account
earnings of both of you. Estimate the shortfall in case there is a break in
earnings of one of you. (For example, let us assume the monthly expenses as
Rs.50, 000. Spouse’s earnings are Rs.30, 000. The shortfall is Rs.20, 000).
Assess how many years this shortfall continues.
4.
Investment income and income from other sources: Calculate the
accumulated total income from savings, investments made, terminal benefits from
the employer in case of sudden demise of the bread winner. Also, take into
account rental income, if any, you are getting.
The quantum of insurance you need is simply the positive
difference between the income you get from investments, properties and other
sources and the total of the gross expenses you incur.
Shyam is aged 37 years. His wife, Sunitha is a housewife.
She is aged 35 years. They have a daughter Kirtana aged 8 years. Shyam’s annual
net post- tax income is rupees 4 lakhs. Their monthly expenditure is Rs.12, 000.
School fee of Kirtana is rupees 20 thousand. He has an outstanding housing loan
of rupees 10 lakhs, paying monthly EMI of rupees 10 thousand. Basing on his
income and expenditure data, let us calculate the amount of insurance he needs.
Policy
value Shyam needs….
Expenses Amount
Domestic expenses (@ Rs.15000 per month for 37
years) - 47,62,657
Kirtana’s educational expenses - 3,00,000
Provision for parent’s financial protection -
5,00,000
Emergency Fund & miscellaneous - 2,50,000
Housing loan - 10,00,000
Personal loans - 1,00,000
Daughter’s higher education - 8,50,000
Daughter’s marriage
- 6,00,000
Total
amount required - 83,22,657
Properties and investments…
Savings account
- 1,00,000
Fixed Deposit - 2,00,000
Value of agricultural field - 5,00,000
Provident Fund - 2,00,000
Gratuity - 75,000
PPF
- 1,00,000
Total
properties/investments - 11,75,000
(After adjustment
of income with domestic expenses – figures in rupees)
From the above table, we will observe that the total expenditure
for the needs amount to Rs.83, 22,657, while the total value of properties/
investments are Rs.11, 75,000. The difference between these is Rs.71, 47,657.
Shyam is presently having insurance for rupees 10 lakhs. He now needs a further
insurance of Rs.61, 47,657. What we could grasp from this example is that in
case something adverse happens to Shyam, his family should get around Rs.58,
87,656.
Hope this article helped you in deciding how much
insurance policies you should take.
Article written by Manmadha Rao, Retired
L.I.C. employee for Wise Money Management
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