Life insurance: How much is enough?
While the decision to buy life insurance may seem simple and straightforward, the biggest decision for most first-time insurance buyers should be ‘how much’ rather than ‘why’. The amount of cover matters even more for buyers who have dependants: too little will place these family members under pressure in unforeseen circumstances.
So, what is that ‘perfect number’ for life insurance coverage?
While there is no one-size-fits-all number, life insurance should provide enough coverage to replace the income of the insured individual in case of his death. A simple rule of the thumb that most buyers follow is to multiply their annual salary by eight.
Breaking it down
A useful method for determining the amount of coverage is to first determine their Human Life Value (HLV). This figure represents the present value of the individual’s earnings and a projection of its future value. HLV is based on three variables:Online GST Certification Course by TaxGuru & MSME- Click here to Join
The age of dependants
If majority of the dependants are of a relatively young age at the time of purchasing the insurance, the buyer must take into account that they will need financial support for a longer period of time.
Current and future expenses
These include recurring as well as major expenses that the family will incur post the buyer’s demise. For instance, children’s education, regular living expenses, and so on.
Existing loans including home loans and car loans, and any financial obligations the family needs to fulfill post the buyer’s death need to be factored in too.
For ease of calculation, assign a tentative figure to each variable. The total sum will reveal the buyer’s HLV, and in turn, the amount of coverage the buyer’s dependents will require. To determine an even more accurate estimate, the buyer may deduct the total of his current assets from this HLV, including existing life insurance policies and the monetary worth of his savings accounts.
While this calculation gives a comfortable approximate, it neglects to take into account the effect of inflation on the purchasing power of the coverage. A good way to counter this is to account for an annual inflation rate of 3–5 percent per annum for regular living expenses, and 8–10 percent per annum for medical and education costs while calculating HLV. Various websites have started offering free online tools to determine the HLV and, consequently, the amount of life insurance coverage required.
Complicated as this may seem, such meticulous planning can go a long way in ensuring that the buyer’s investment in life insurance fulfils the role it was intended to essay – protecting his loved ones and providing for them even after his passing.
Source- HDFC Bank