Recommended Life Insurance Coverage: Secure Your Future | Spring Money

Life insurance is one of the most crucial investments you can make for your family's financial security. In the unfortunate event of untimely demise, life insurance can provide your loved ones with a lump sum payment to help them pay off debts, cover daily expenses, and maintain their lifestyle.

The COVID-19 pandemic has taken the life insurance buying decision under the spotlight. Following this, there has been a notable increase in demand for life insurance plans.

However, the question that many people struggle with is, "How much life insurance is adequate?".

Determining the right amount of life insurance coverage can be challenging, but it's highly essential to ensure that you're not underinsured. Underinsured means that you don't have enough coverage to meet your family's financial needs.

To help you out, we've got two methods, to choose adequate life insurance coverage to protect your loved ones' dreams and goals:

1. The Thumb Rule method: Quick and easy - perfect for those who want a simple solution.

2. The evaluation-based method: Takes more time and thought, but provides a more in-depth approach to choosing the right plan.

Thumb Rule Method

This straighforward method is based on simply multiplying your annual income as per your family's finances and lifestyle.

Let’s understand this with the example of an unreal guy, Ajay. He is a 25-year-old software developer earning ₹6 lakhs per year and is currently unmarried. He comes from a middle-class family that has no significant financial support or massive debts. Using the Thumb rule method, Ajay can calculate the sum assured or the amount of money needed to meet his family's requirements by multiplying his annual salary by either 6 or 8.

Sum assured = ₹6 Lakhs X 6 or 8

=₹36 to ₹48 Lakhs.

Ajay is unmarried and has no kids, so after his demise, this amount could be enough to cater for some major needs of his family like education and marriage of siblings, paying any remaining debts, or investing that amount to earn some returns that could act as a pension for his parents.

Similarly, after 5 years Ajay turned 30, got married and had a kid. Now his liabilities have changed completely, and presently his family would require a much more insurance amount(sum assured) in his absence. Now with the thumb rule, he could multiply his income by 10. In 5 years Ajay’s annual income will also grow, we have considered it to be ₹15 Lakhs annually.

Sum assured = ₹15 Lakhs X 10

=₹1.5 crores.

With more liabilities, the number must keep growing. If Ajay gets a home loan then depending on the EMIs and tenure the number could be 12.

The thumb rule method depends on the simple concept of growing the sum assured by multiplying these numbers with your annual income. The more liabilities, the greater this number should be.

Most experts suggest that the number taken to multiply with annual income must not be less than 10 for someone who has dependents, debts or both.

Evaluation-based Method

To determine the appropriate payout from your life insurance policy, it's important to evaluate your overall financial situation. This includes examining your expenses, debts, financial goals, and investments. By taking these factors into account, you can calculate the amount of coverage you require.

• Evaluate Your Monthly Expenses: Track every penny you spend to know how much coverage you'll need. From groceries to rent to fuel, don't forget any expenses. To make sure your family has enough funds to manage their expenses in your absence for the next 20 years you have to make calculations considering a few factors. Suppose Ajay’s family has an average monthly expense of ₹25 thousand so for the next 20 years “hypothetically” his family would require, ₹25 thousand X 12(months) X 20(Years) = ₹60 lakhs. Confuse about why I highlighted hypothetically? Because of the inflation! To top up your scooter's empty tank in 2023 could cost you around ₹600, but in 2028, it may increase to around ₹900 due to an average inflation rate of 6% in India. Similarly, every other thing that falls under expense(rent, fuel, electricity) will demand more amount than what it is demanding at present. Then, how to calculate the expense amount? when you don't know after how many years any misfortune would occur. In reality, it’s actually a bit of a task and no one could suggest an exact figure so what we would suggest is, to increase the amount required presently by 50%. In Ajay’s case, this would be, ₹60 lakhs + ₹30 lakhs(half of the present expenses amount) = ₹90 lakhs, this should be considered as the right amount for expenses.
  

• Evaluate Your Liabilities: Don't leave your loved ones with your debts. Take into account all outstanding loans, and other dues. If Ajay has an outstanding home loan EMI of ₹22 thousand for the next 8 years and a car loan EMI of ₹12 thousand for the next 3 years then his total loan liability is; ₹22 thousand X 12(months) X 8(years) + ₹12 thousand X 12(months) X 3(years) = ₹25.5 lakhs Now, this amount will remain fixed, the EMIs will remain the same throughout their tenure so no need to worry about inflation here.
  

• Evaluate Your Goals: Your financial goals, like saving for your child's education or marriage shouldn't suffer because of the unexpected. A suitable amount from your insurance policy can help your family continue to achieve them in your absence. Ideally, you can calculate the funds required for a child’s education and for marriage. Ajay who at 30 has a daughter is dreaming of sending her for higher education at a reputed institute and he expects that it would cost around ₹20 lakhs presently. He also wants to spend ₹20 lakhs for her marriage. So the total amount for Ajay’s goals is ₹40 lakhs. To account for inflation, we need to add an additional 50% to the amount we calculated earlier, just as we did when evaluating expenses. Now, this amount will grow to ₹60 lakhs.
  

• Evaluate Your Savings/Investments: You must not forget to consider your investments, be it your PPF, EPF, NPS, bank FD, or any investment in equity, mutual funds and other savings if any. Let’s imagine that Ajay has ₹15 lakhs worth of investments in today’s cost.

Life cover that Ajay requires with this method = His Expenses+ Liabilities+ Goals - Savings/investments = ₹90 lakhs + ₹25.5 lakhs + ₹60 lakhs - 15 lakhs = ₹1.6 crore

Now, you can see that the output from both methods is somewhat close. However, both methods could give results that might have a noticeable difference.

Conclusion

Apart from the sum assured one thing that also is very important is choosing a life insurance policy that fits your requirements better. To know about different types of life insurance policies and understand which one should you pick, Click Here- Comparison of Different Life Insurance Plans.

It's crucial to keep in mind that your expenses, goals, and liabilities are subject to change over time. Therefore, it's essential to review your life insurance coverage or sum assured, periodically to ensure that it provides your family with the necessary financial protection. If your existing policy doesn't meet your requirements, consider renewing it or taking out a new policy, so together they serve the purpose.