The main purpose of buying life insurance is to make sure that your family is financially secure if you aren’t around to take care of them.
That you already know, but majority of insurance buyers do not look at insurance as a protective instrument and use it as a financial investment. Their only concern is the returns it provides. It’s very important to determine the cover based on your family’s needs.
Before looking at how much insurance cover you require, here are two thumb rules you must follow before buying any life insurance plan.
Rule1: The first golden rule when buying life insurance is to make sure that the cover is big enough to cater to all debts and financial needs of your family. A common method suggested by experts is to get a cover between 10 to 12 times your annual income.
So, if you earn Rs. 50,000 per month, the minimum insurance cover you should opt for must be greater than Rs. 60 Lakhs (50,000*12= 6, 00,000) *10.
Rule 2: The sum insured for your life insurance plan must be that amount, which if invested, can fetch a regular income for your family members in your absence. The amount will vary as per your lifestyle and income. But do not forget to figure in any liabilities you may have, like pending loans.
Let’s assume you have a home loan of Rs. 40 Lakhs, a car loan of Rs. 5 Lakhs, and your family needs Rs. 40,000 per month to live a comfortable life. Your insurance cover, in such a scenario, must be an amount that can earn Rs. 40,000 per month after liquidating all your outstanding loans.
Additional read: 6 myths about life insurance busted
Simplifying Insurance Covers
Let’s figure out how much insurance you may need by understanding some real life examples.
Case 1: Ravi Kumar, 35 year old management graduate
Ravi’s monthly salary= Rs 50,000
Monthly Expenses= Rs 25,000
Time till retirement= 25 years
While 25,000 is sufficient for his family needs today, over a period of time he will need money for his children’s education, marriage etc. Also, inflation over a period of time will mean that his family will need more money to maintain their lifestyle.
Taking the inflation rate as 4% and applying the principles of compound interest
Monthly Expenses at the time of retirement = 25000 x (1+4%)25 = Rs 66,646
Therefore, Ravi’s expenses at the time of his retirement would be close to Rs. 66,646 per month instead of Rs. 25,000.
Figuring in health related requirements and other expenses,
The actual insurance requirement = 120% of 66646 = Rs 79975
Ravi, therefore, needs a minimum sum insurance cover of Rs. 80 Lakhs.
Case 2: Mohan, sound engineer with a music company and his wife who works at an MNC
Mohan’s monthly salary = Rs. 1 Lakh per month
His wife’s monthly salary = Rs. 75,000 per month.
The couple lives in their own home and has no home loan or car loan obligations. Replacement income, therefore, is not that essential for Mohan.
Mohan’s insurance cover should provide for all future expenses,
Their child’s higher education = Rs. 20 Lakhs
Their child’s marriage = Rs. 20 Lakhs
Other miscellaneous needs = Rs. 20 Lakhs
Health care needs for his wife and children = Rs. 20 Lakhs
Total = Rs. 80 Lakhs
So the total sum assured for Mohan should be more than a minimum threshold figure of Rs. 80 Lakhs.
There is no one amount that is safe as an insurance cover for everyone. The amount depends on your earnings, liabilities and lifestyle. Taking insurance without knowing your insurance cover could possibly go completely against your intentions.
It is also important to review your life insurance every few years. Find out more here: Is it time to review your life insurance?