How much Life Insurance coverage should one have?
Most of us are not aware of “how much” insurance one needs to purchase to protect one’s family or for future requirements. Let us understand the factors which influence the amount of insurance coverage one should purchase to have a good night’s sleep.
Income Replacement
One of the biggest factors for life insurance is income replacement, which is a major determinant of the size of your Life Insurance policy. The simplest way to understand it is if you are earning a certain amount every year for your family, then you need a policy that provides for an interest-earning of an equivalent amount.
Currently, a large portion of the income goes to taxes and to maintain your own lifestyle. Hence the income, net of taxes, needs to be determined for the calculation of Life Insurance Requirements as Insurance Benefits are usually Income Tax-free.
For example, if your Income, net of taxes, is Rs 5 lakhs in a year, then you need an ‘A’ amount of Sum Assured which if invested as a Fixed Deposit in a bank at 8% interest per annum will fetch an interest of Rs 5 lakhs in a year’s time.
8% x A = Rs 5 lakhs
Or, A = Rs 5 lakhs / 8%= Rs 62.5 lakhs
Thus Sum Assured requirement is a minimum of Rs 62.5 lakhs which doesn’t include inflation so as to ensure that the income of the earning member of the family can be replaced by interest earning on the Sum Assured without depleting the actual principal amount.
Income replacement for nonworking spouses is also an important and often overlooked insurance need. Coverage should provide for your costs for daycare, housekeeping, or nursing care. Any net earnings from part-time employment also need to be added to this.
However as simple as it may sound, calculating it is not very easy, since there are other factors that need to be added.
The Amount of Debt or Loan
This is another very important factor while calculating Insurance requirements to ensure that the liability to repay the same does not fall on your dependents. All your debts must be paid off in full, including car loans, home loans, credit cards, personal loans, etc. If you have a home loan of Rs 10 lakhs and a car loan of Rs 4 lakhs, then you need at least Rs 14 lakhs in your policy to cover your debts (and possibly a little more to take care of the interest as well).
Hence in addition to Rs, 62.5 lakhs (from the above example), Rs 14 lakhs + interest= Rs 77 lakhs (assuming Rs 50,000 as interest) need to be added as a loan component for repayment.
Child Education Requirement
With the constant increase in the cost of education becomes an important factor in the calculation of Insurance requirements. Basic school education needs to be considered initially.
Fee per month x 12 months in a year x Number of years remaining for a child to complete education is the amount that needs to be added to the Insurance Requirement.
For example: If the fee is Rs.2000 per month and the child is in 2nd class – Rs 2000 x 12 months x 10 years remaining for the child to complete class 12 = Rs.2.4 lakhs, which needs to be added to Insurance Requirement. Higher Education needs to be factored in separately depending on what you would want your child to study and where and how much you are willing to spend on his or her education.
Thus, in continuation with the previous example, Rs 2.4 lakhs need to be added to the Insurance Requirement of Rs 77 lakhs, which equals Rs 79.4 lakhs, plus maybe an amount of Rs 10 lakhs for the child’s higher education, totaling Rs 90 lakhs approximately.
Dreams and Goals
All dreams and goals need to be considered separately as it is not a necessity but only a wish of the Life Insured. New house, car, foreign trips, child’s wedding, etc. would fall under this category. The amount that you wish to spend on such an occasion needs to be added to the Insurance Requirement, after incorporating the inflation
For example, if you wish to spend Rs 10 lakhs for your daughter’s wedding 15 years later and the expected rate of Inflation is 6%, then you actually need to add Rs 23.966 lakhs to the Insurance Requirement instead of Rs 10 lakhs.
Insuring Others
Obviously, there are other people in your life who are important to you and you may wonder if you should insure them. As a rule, you should only insure people whose death would mean a financial loss to you. The death of a child, while emotionally devastating, does not constitute a financial loss because children do not contribute to the household income. The death of a spouse, whether earning or not, does create a situation with both emotional and financial losses and hence needs to be insured.
Easy Calculation of Insurance Requirements
There is a quick calculation without getting into such nitty gritty. Multiples of annual income are considered according to the different age groups.
This is a simple and quick reference to calculate the Life Insurance Requirement. Although it would not apply to everyone uniformly, it gives an approximate value for the same.
| Between the Age Group | Multiple Annual Income |
| 20 years – 29 years | 20 times Annual Income |
| 30 years – 39 years | 15 times Annual Income |
| 40 years – 55 years | 10 times Annual Income |
| More than 55 years | 5 times Annual Income |
Conclusion
The topic of calculating the Insurance Requirement amount has always been a much-debated topic as it is very difficult to calculate the EXACT amount of financial loss that the family would face in one’s absence. Hence there have been many ways and means to come to a figure that is somewhat close to the actual requirement. The factors mentioned above, if considered and calculated appropriately, also would yield a result somewhat close to the actual Insurance Requirement.
Calculating the actual figure for Insurance Requirements is not possible. Do you really think it is possible to quantify exactly “how much” financial loss a family would face in a person’s absence? Only when the person is actually absent, the family gets to feel the difference. Till such time, a lot of small aspects of life are taken for granted and are not really valued.
Therefore arriving at a conclusive figure of the exact amount of Insurance Requirement depends a lot on assumptions and expected loss. The rate of expected inflation, the future value of money, and other factors considered are all assumptions.
Being adequately covered would also ensure a good night’s sleep without having to worry about the family’s security. Or, are we putting our families in the slightest trouble if something unfortunate were to happen? Thus, the above factors and calculations would now help a lot of us to re-value ourselves and find out if we are adequately covered or not.
