We always want the best for our family and life is full of uncertainties. There is an ‘IF’ in ‘LIFE’. Hence planning for the contingencies and taking concrete steps to secure our family’s future is of utmost importance. For there is no way to ascertain as to when one might lose the ability to provide for them due to disability or the sudden loss of life.
Insurance Planning is one of the most important pillars of Financial Planning. This is because Life Insurance is the only tool which can fulfill financial commitments in case of untimely death of the bread earner of the family. Thus having an appropriate life cover is important.
Why Insurance Planning is required?
People today prefer to take loans to fulfill their needs, instead of waiting to save for the future. Hence, in your absence, your family needs to take care of this loan
Nuclear family structure:
Earlier, people could depend on their extended joint family system to take care of their near and dear ones in case of their absence. However, the share of families with more than 5 members has come down from 64% in 1990 to 56% in 2005 and is expected to decrease further.
Increasing lifestyle diseases:
People these days are prone to many diseases as a result of which the longevity of life is also reduced. Thus it gets important to take an appropriate risk cover and give your family a financially secure future.
Loans & Liabilities:
Insurance policy also helps to cover up one’s loans and liabilities. The house one buys for our shelter, we would never want to let it go. Thus an insurance policy can help one to cover the loan liabilities.
How much Life Cover should one take?
Calculating how much life insurance you need is one of the most important financial decisions you will ever make. It should never be an isolated decision depending only on how much of a premium you can afford.
Life Insurance needs can be calculated in the following methods:
Income Replacement Value (Rule of Thumb)
This is one of the basic methods of insurance calculation and is based on your current annual income.
Insurance needs = annual income * number of years left for retirement.
Let’s say your annual income is Rs 5,00,000. And you are 45 years old with 15 more years for retirement.
Another way in which income replacement works is to multiply the annual income by 10 (also known as Income Replacement Multiplier).
Human Life Value (HLV)
This method of calculating life insurance is based on contribution that one makes and would have made to her/his family in case of sudden demise. So HLV is defined as the present value of all future income that you could expect to earn for your family’s benefit. It also includes other value you expect to contribute, less personal expenses, life insurance premiums and taxes through your planned retirement date.
So if your age is 35 yrs old, your annual income is 20 lacs and your personal expenses are 5 lac. Assuming inflation rate of 5% p.a. and that you plan to work till 60 yrs, your HLV will be ` 2,21,97,963.
Total Needs Approach
In this method, you can assess your needs — and the needs of your loved ones — and make a calculated assessment. The most critical factors are the number of dependents you have and their needs. Other major factors to consider are:
- Kind of lifestyle you want to provide to your family
- Provision for non-working spouse who would no longer get an income
- Child’s education
- Child’s marriage
- Providing for financially dependent parents
- Special needs
- Dreams and aspirations such as contributing to charitable causes
- Once you determine the above factors, you run the following calculations:
Lump sum needs on Life to be Insured’s death
- Home loan payoff
- Car loan payoff
- Child’s education
- Child’s marriage
- Emergency fund post death
Monthly income needs
- Monthly expenses
- Income of Living spouse in case she earns, or rent or interest
- Shortfall = (a-b)
Shortfall is a-b. Suppose, expenses are Rs 50,000 and spouse’s income is Rs 30,000 post tax, then shortfall is Rs 20,000 (50,000-30,000).
- Monthly income needs till child turns 21 or is self-sufficient:
- Number of years to go: For the child to reach 21 and post that for the spouse till her age of 80 or 90 years
- Annual income needs: Of spouse, children or dependents
- Total income needs: Of spouse, children or dependents
When to start for your Insurance Planning?
Look at the table below:
It shows the premium amounts that an individual at different ages would pay for a risk cover of Rs.1 Crore for 20 years.
There is a difference in the premium amount if you take insurance at later ages. This is because the probability of diseases is larger at high ages and mortality is high.