A crucial aspect of financial planning requires you to think about hard times. Keeping a rainy day fund and having multiple investments to grow your wealth is always recommended. But what about a situation when you are no longer around, and your family is left to fend for themselves? This is where we foray into life insurance. It is the first solution that springs to mind as a contingency plan. The goal of purchasing life insurance products is to give your family much-needed financial backup in the event of your untimely passing. They will be able to continue living their regular lives thanks to the coverage. But have you chosen a suitable coverage amount to take care of this aspect?
This article will discuss some of the critical factors to consider when determining how much life insurance coverage you need and how to choose the right policy.
4 Basic Steps to Ensure You Choose The Right Life Cover
When you are looking to buy a life insurance policy, it is good to consider the following four parameters:
- Determine your coverage needs: The first step in choosing the right life insurance coverage is to determine how much coverage you need. This will depend on several factors, such as your income, debt, and the number of dependents you have. If you have significant debt, you may need more coverage to ensure that the same is paid off in the event of your death within the policy period.
- Consider your life stage: Your life stage will also play a role in determining the right life insurance coverage for you. For example, if you are young and have a family, you may need more coverage than if you are retired and have no dependents. Additionally, suppose you have a young family and expect your income to increase. In that case, you may want to consider a term life insurance policy that gives you the option to advance your coverage with gradual increases in your income.
- Current Financial Liabilities: Consider all the assets you’ve acquired using loans. If you pass away, your family will be forced to pay these debts, which is the last thing you want to happen. Make a list of all the loans you have taken out. Then, investigate several term insurance options that can offer adequate protection at a reasonable cost.
- Choose The Right Type Of Policy: In India, various types of life insurance policies are available. From a pure life insurance standpoint, you can choose either term life insurance or whole life insurance. Many other plans, like Endowment Plans and Unit Linked Insurance Plans. You must read about each of these and decide the right one for your needs.
Methods for calculating life insurance coverage
There are multiple calculation methods available, although you can use an online calculator to determine the amount you will get as coverage for a certain premium amount. This is where you can keep tweaking the premium (per your desired budget) to arrive at the coverage suitable to meet your needs.
Some handy methods for working out the term insurance coverage that you require include the following:
- Human Life Value (HLV) – This method takes an individual’s economic value or lifetime value in the household. This mainly accounts for future expenses, income, investments, and liabilities. Income, expenditure, expected future goals, and responsibilities should be considered, keeping inflation at the forefront.
- Income Replacement – This method assumes that the insurance coverage should replace the policyholder’s lost income. The calculation method is Current Annual Income x Years Left to Retirement. For example, if you have 10 more years for retirement and earn Rs. 20 lakhs per year, you will require (20 lakh x 10) Rs. 2 crores as coverage.
- Expenditure Replacement- Most planners recommend this calculation method, which accounts for liabilities, daily expenditures, future goals, and providing for dependents. The total amount is what the family will require. Then one should subtract the current value of existing life insurance cover and investments. You should exclude assets like your car and house. The final amount will indicate the sum that is required.
- Underwriter’s Method – The thumb rule primarily followed in the sector is a sum assured that is ten times the policyholder’s income. Hence, assuming you earn around Rs. 25 lakhs per year, your sum assured should be Rs. 2.5 crores under this method. However, experts feel this may sometimes be inadequate and recommend coverage 15-20 times one’s annual income.
Your current coverage may appear inadequate because your life value is increasing or the value of your life goals has increased or altered. If this is the case, consider revising your coverage or purchasing a new policy. Coverage enhancement allows you to boost the sum assured by a defined amount at certain life milestones, such as marriage or the birth of a child, but keep in mind that this may also increase the premium.
It makes sense to evaluate prices and plans based on your needs. Seek professional advice to assess the policy type and coverage that will best suit your budget and your family’s financial demands.