5 rules on how much insurance you need
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K.Karthik Raja
Jul 18, 2008, 4:10:51 AM7/18/08
to Kences1
5 rules on how much insurance you need
If you are an earning member of your family, and there are members of
your family who are financially dependant on you, you need life
insurance. But how much life insurance do you need?
There are many factors that are relevant in determining the amount of
life cover you should buy.
Need for minimum protection. It is essential that a particular level
of income should be maintained for the family even when its
breadwinner is not around. Suppose a family's present needs are Rs
25,000 p.m. The extent of life insurance for its earning members
should be such that interest income from the sum assured can meet the
family's monthly expenses of Rs 25,000.
If one also wants to provide for the future fall in the purchasing
power of rupee due to inflation, one must necessarily take policies
for higher amounts. No widow, they say, has ever complained that her
husband bought too much insurance.
Current income level Payment of insurance premium results in an
outflow of disposable income. You may, therefore, not like to buy too
much insurance. One might have to limit the quantum of insurance
keeping in mind the cash flow problems that will be created as a
result of the obligation of regular payment of insurance premia.
Tax benefits
You should also take into account the tax benefit under Section 80C.
Accumulating for specific needs
If you expect to spend a particular sum of money for the education
and / or wedding of your children, you may like to buy an insurance
policy for a specific sum to meet such a lump sum commitment.
Present age
Your present age is a critical factor in deciding the quantum of
insurance that you can afford. The rates of premium go up with the
advancing age of the life assured. Hence, one can buy more insurance
for the same premium at a younger age than at an older age.
The final decision rests upon a careful consideration and balance of
all the above factors. The need for minimum protection may be quite
high, but the current need for disposable income may not immediately
permit buying adequate insurance.
You then have to make a compromise and buy extra insurance as and when
you can afford it.
The 5 simple rules
In the event of any misfortune, well-planned life insurance can
protect your loved ones from financial difficulties. However, in most
cases, people find it difficult to estimate the correct value of
insurance they need.
Partly this is because life insurance needs change through different
stages of life. Young people with no dependants may not have much need
for life insurance.
As one's family responsibility grows, life insurance needs too
increase. Thus, a periodical review based on your family circumstances
is required in order to ensure that the coverage is adequate.
There are several simple methods available to broadly estimate your
life insurance needs. Five simple rules are:
1. Income rule
The most basic rule of thumb is provided by the income rule which
holds that individual insurance cover should be at least around eight
to ten times one's gross annual income. For example, a person earning
a gross annual income of Rs 1 lakh should have about Rs 8 to10 lakh in
life insurance cover.
2. Income plus expenses rule
This rule suggests that an individual needs insurance equal to five
times your gross annual income, plus the total of basic expenses like
housing or car loans, personal debt, child's education, etc.
3. Premiums as percentage of income
By this rule, payment of insurance premium depends on disposable
income. In other words, one should decide the quantum of insurance
after meeting the regular outgo from salary.
From the first two rules, you can make a broad estimate of the minimum
insurance you should have. The premium as percentage of income rule
can help you fine-tune your cash flow by committing an appropriate
percentage of your income for paying life insurance premium.
4. Capital fund rule
This rule suggests that if you need Rs 1 lakh p.a. for your family
needs, and assuming you do not have any other income-generating
assets, you may like to create a capital fund of Rs 12.5 lakh (Rs 1.25
million) which can yield Rs 1 lakh (Rs 100,000) annual income @ 8%
p.a. You may therefore buy a life insurance policy of Rs 12.5 lakh.
5. Family needs approach
This rule holds that you purchase enough life insurance to enable your
family to meet various expenses in the event of key earning person's
death. Under the family needs approach, one has to divide his family's
needs into two main categories: immediate needs at death (cash needs),
and ongoing needs (net income needs).
Stage of Life
Needs
Assets
Initial stage. No family responsibilities.
Premature death leads to minimal needs like funeral expenses
No worthwhile assets. Just a beginning. May be some cash balance.
Married, with children.
Premature death causes serious financial problems, as most of the
needs continue
Some assets available. Growing assets
Empty nest
The needs decline once children grow up and get settled. No major
financial problems
Strong assets base, surpassing the financial needs
You may also like to keep in mind that if your family is reasonably
wealthy and its protection needs relatively low, you can buy a smaller
amount of insurance. Similarly, if your family members have
independent earning capacity you may reduce your insurance.
There is a broad relationship between needs and assets over a period
of time. Thus, not much life insurance is needed in the initial stage.
The same is true in the empty nest stage.
The maximum need for life insurance arises during the mid-phase, when
one is married and has children. In other words, one may go for life
insurance so long as the asset-level is lower than the need-level. As
highlighted in Figure 1, once the asset-level surpasses the need-
level, the importance of life insurance declines.
Caution: Insurance is not investment You should always remember that
life insurance is a protection and not really an investment because
financial returns are rather meagre. (This is equally true of the life
insurance portion of even a ULIP scheme.)
If you take inflation into account, there could even be a negative
rate of real return at the time of maturity of your insurance
policies. So, while it's important to secure your family's well being
through adequate insurance of the lives of the earning members, over-
investing is a mistake.
If you are an earning member of your family, and there are members of
your family who are financially dependant on you, you need life
insurance. But how much life insurance do you need?
There are many factors that are relevant in determining the amount of
life cover you should buy.
Need for minimum protection. It is essential that a particular level
of income should be maintained for the family even when its
breadwinner is not around. Suppose a family's present needs are Rs
25,000 p.m. The extent of life insurance for its earning members
should be such that interest income from the sum assured can meet the
family's monthly expenses of Rs 25,000.
If one also wants to provide for the future fall in the purchasing
power of rupee due to inflation, one must necessarily take policies
for higher amounts. No widow, they say, has ever complained that her
husband bought too much insurance.
Current income level Payment of insurance premium results in an
outflow of disposable income. You may, therefore, not like to buy too
much insurance. One might have to limit the quantum of insurance
keeping in mind the cash flow problems that will be created as a
result of the obligation of regular payment of insurance premia.
Tax benefits
You should also take into account the tax benefit under Section 80C.
Accumulating for specific needs
If you expect to spend a particular sum of money for the education
and / or wedding of your children, you may like to buy an insurance
policy for a specific sum to meet such a lump sum commitment.
Present age
Your present age is a critical factor in deciding the quantum of
insurance that you can afford. The rates of premium go up with the
advancing age of the life assured. Hence, one can buy more insurance
for the same premium at a younger age than at an older age.
The final decision rests upon a careful consideration and balance of
all the above factors. The need for minimum protection may be quite
high, but the current need for disposable income may not immediately
permit buying adequate insurance.
You then have to make a compromise and buy extra insurance as and when
you can afford it.
The 5 simple rules
In the event of any misfortune, well-planned life insurance can
protect your loved ones from financial difficulties. However, in most
cases, people find it difficult to estimate the correct value of
insurance they need.
Partly this is because life insurance needs change through different
stages of life. Young people with no dependants may not have much need
for life insurance.
As one's family responsibility grows, life insurance needs too
increase. Thus, a periodical review based on your family circumstances
is required in order to ensure that the coverage is adequate.
There are several simple methods available to broadly estimate your
life insurance needs. Five simple rules are:
1. Income rule
The most basic rule of thumb is provided by the income rule which
holds that individual insurance cover should be at least around eight
to ten times one's gross annual income. For example, a person earning
a gross annual income of Rs 1 lakh should have about Rs 8 to10 lakh in
life insurance cover.
2. Income plus expenses rule
This rule suggests that an individual needs insurance equal to five
times your gross annual income, plus the total of basic expenses like
housing or car loans, personal debt, child's education, etc.
3. Premiums as percentage of income
By this rule, payment of insurance premium depends on disposable
income. In other words, one should decide the quantum of insurance
after meeting the regular outgo from salary.
From the first two rules, you can make a broad estimate of the minimum
insurance you should have. The premium as percentage of income rule
can help you fine-tune your cash flow by committing an appropriate
percentage of your income for paying life insurance premium.
4. Capital fund rule
This rule suggests that if you need Rs 1 lakh p.a. for your family
needs, and assuming you do not have any other income-generating
assets, you may like to create a capital fund of Rs 12.5 lakh (Rs 1.25
million) which can yield Rs 1 lakh (Rs 100,000) annual income @ 8%
p.a. You may therefore buy a life insurance policy of Rs 12.5 lakh.
5. Family needs approach
This rule holds that you purchase enough life insurance to enable your
family to meet various expenses in the event of key earning person's
death. Under the family needs approach, one has to divide his family's
needs into two main categories: immediate needs at death (cash needs),
and ongoing needs (net income needs).
Stage of Life
Needs
Assets
Initial stage. No family responsibilities.
Premature death leads to minimal needs like funeral expenses
No worthwhile assets. Just a beginning. May be some cash balance.
Married, with children.
Premature death causes serious financial problems, as most of the
needs continue
Some assets available. Growing assets
Empty nest
The needs decline once children grow up and get settled. No major
financial problems
Strong assets base, surpassing the financial needs
You may also like to keep in mind that if your family is reasonably
wealthy and its protection needs relatively low, you can buy a smaller
amount of insurance. Similarly, if your family members have
independent earning capacity you may reduce your insurance.
There is a broad relationship between needs and assets over a period
of time. Thus, not much life insurance is needed in the initial stage.
The same is true in the empty nest stage.
The maximum need for life insurance arises during the mid-phase, when
one is married and has children. In other words, one may go for life
insurance so long as the asset-level is lower than the need-level. As
highlighted in Figure 1, once the asset-level surpasses the need-
level, the importance of life insurance declines.
Caution: Insurance is not investment You should always remember that
life insurance is a protection and not really an investment because
financial returns are rather meagre. (This is equally true of the life
insurance portion of even a ULIP scheme.)
If you take inflation into account, there could even be a negative
rate of real return at the time of maturity of your insurance
policies. So, while it's important to secure your family's well being
through adequate insurance of the lives of the earning members, over-
investing is a mistake.
suguhopes
Jul 19, 2008, 2:43:51 AM7/19/08
to Kences1
If you are an earning member of your family, and there are members of
your family who are financially dependant on you, you need life
insurance. But how much life insurance do you need?
There are many factors that are relevant in determining the amount of
life cover you should buy.
Need for minimum protection
your family who are financially dependant on you, you need life
insurance. But how much life insurance do you need?
There are many factors that are relevant in determining the amount of
life cover you should buy.
Need for minimum protection
Research Analyst
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