HOW MUCH LIFE INSURANCE COVER DO YOU NEED?

2020 is the year we have realized the importance of having adequate insurance covers to protect families against any financial shocks. Amidst the fears of corona virus and living for weeks under closed walls, we have realized how uncertain and vulnerable our lives are. We have realized that our we and our families deserve financial security in life. Most of us are today thinking of having adequate life insurance. Life insurance is nothing but a provision for providing for the financial future of your family in such a way that your absence does little or no financial harm to your family. The very critical element of this provision is the

extent /cover of it. It should be adequate enough to provide for your family in your absence.

HOW MUCH YOU NEED?

One cannot pinpoint the exact amount of life insurance one needs. But there are many methods of arriving at a sound estimate for your coverage requirement. In general, you can find the ideal life insurance amount by calculating your long-term financial obligations or goals and then subtracting your existing assets. The gap between the two would be your need. It is however not easy to calculate the same. Here are a few thumb rules and methods which you can explore while calculating the same:-

Income Replacement Method.

One objective for life insurance is to replace income. Under this very simple method, we would just multiply the income of the person with the number of years of active employment left. For example, for a person aged 40, having a monthly net income Rs.100,000 and a retirement age of 60, there would be 20 years of active service left. One can now simply multiply Rs.12 lac yearly x 20 times. This will give you a life insurance need of Rs.2.4 crores, a fair indication of what we should ideally have. Of course, there are some key parameters ignored here like the yearly growth in the income, inflation, your present expenses and the likely return on the investment of the corpus, etc. We could calculate those things but that would be just a numerical exercise. The understanding of the underlying concept is more important.

Withdrawal Ratio Method

Under this method, it is assumed that the policy proceeds will be invested and the income/withdrawals from this investment should be sufficient to finance your expenses over the foreseeable future. Note that in the previous method we will be considering the entire net income and here we are only considering a part of it which goes towards financing household expenses. Let us see this with an example. Your monthly expenses are said Rs.50,000 amounting to Rs.6,00,000 yearly. With a withdrawal rate of say 4%, the corpus needed would be Rs.1.50 crore (Rs.6,00,000 divided by 4% or 0.04). The 4% is a very popular rule, based on some studies indicating a long-term sustainable withdrawal rate to calculate retirement kitty need. We borrow the idea here. To be on a safer side, a lower withdrawal rate of 3% would give us a higher amount of Rs.2 crore (6 lac / 0.03). The assumption is that the investment corpus would continue to grow to match growing expenses with inflation. Theoretically, in the absence of any huge expenses, this amount should be sufficient to finance your expenses. Again there are limitations in this method and one may fine-tune this further and use the results with care.

CONCLUSION

We would strongly suggest that one approaches a qualified insurance advisor or a financial planner to help you make the calculations and arrive at the right figure. We also hope that you assess your present life insurance cover in the context of this article, take adequate life cover as soon as possible and enjoy peace of mind.