Investing in a life insurance plan is one of the best decisions you can make. Even if you are not earning good income, do not hesitate in purchasing a life insurance policy. Another reason for purchasing a life insurance plan is to provide for your dependents in case something happens to you in the near future. A life insurance plan will help your family meet major financial liabilities in case of an emergency. But the general rule remains the same- ‘always do your research before purchasing an insurance plan’. You should buy an insurance plan which goes well with your financial capacity and at the same time, provides adequate life cover.
The market is filled with different insurance plans. Each plan comes with several features. Thus, you should consider multiple factors before investing in a life insurance plan. Let us understand how to purchase the right insurance plan as per your income.
To begin with, you need to determine the amount of life cover. Post calculating the sum assured, you should consider the following:
Current Expenditure
Investing in a life insurance plan can be an expensive affair. Before purchasing a life insurance plan, you need to ensure that your family’s lifestyle and standard of living are not affected in any way. One simple method is to add all the monthly expenses and multiply the same with 12. This will help you determine the overall expenses within the year. Additional expenses to consider are premium expenses (you and your family), monthly expenditure including utility bills, groceries, children’s education fees and miscellaneous expenses.
The expenses mentioned above are basic expenses, they are a necessity which cannot be avoided, even when you are gone. As a policyholder, you need to calculate the cost of basic expenses with respect to the rate of inflation.
For Example: If your basic yearly expenses are Rs. 4,00,000 per year and the rate of inflation is around 7% for the same year. Fast forwarding 10 years, the same expenses will cost Rs. 13 lakhs, thanks to inflation. Keeping this in mind, your average cost of expenses should be taken as Rs. 7 lakhs per annum. Based on this assumption, you will require a sum assured of Rs. 1.4 crore (7,00,000* 20 (Number of years until retirement).
Income Multiplier Method
This is also an interesting and effective method which can be used to determine the desirable sum assured for you and your family. Under this method, you have to simply multiply your income by the age group to get an estimation of the desired sum assured. In the next step, deduct your expenditure from your net income and then use the factor of multiplication.
For Example: If you fall in the age group of 20-30 years, the minimum insurance coverage will be calculated by multiplying the income by a factor of 15. The maximum insurance coverage can be calculated by multiplying the same by a factor of 20.
An ideal scenario is not to just base your calculation during the time of purchasing the policy. You should re-evaluate the sum assured every five years. This will help you understand the growing needs of your family. This method is one of the best ways to figure out the sum assured of a particular policy.
Assets and Liabilities
Your current assets comprise of your income, wealth, gold, property, cars, securities and anything of tangible value. On the other hand, your liabilities comprise of home loan, car loan, existing debt, expenses, etc. After calculating your assets and liabilities, you will have a better idea on computing the amount of sum assured.
To help you understand better, you can go through the following example of Mr. Johnny:
Mr. Johnny has an annual income (A) of Rs. 15 lakhs (excluding savings and investments) with current monthly expenses of Rs. 35,000.
The rate of inflation (B) is 5%.
Mr. Johnny’s current age (C1) is 40 years.
Let us consider Mr. Johnny’s retirement age (C2) as 60 years.
The number of years to retirement (C) is 20 years (60 years - 40 years).
Mr. Johnny is a family man (one wife, one son, one daughter). His future expenses comprise of child’s wedding expenses after 15 years, higher education expenses after 10 years, wife’s medical expenses, etc.
Keeping inflation in mind, children’s education which costs Rs. 5 lakhs now, will cost Rs. 10 lakhs post 10 years.
Mr. Johnny’s daughter’s wedding costs Rs. 2 lakhs now, post 15 years, it will cost around Rs. 5.5 lakhs. Additionally Mr. Johnny has to consider expenses for both his kids and wife. So, the total expenses come upto Rs. 17.5 lakhs (D).
Currently, Mr. Johnny has savings (E) worth Rs. 5 lakhs (bank balance, fixed deposits). On the other hand, Mr. Johnny has existing liabilities (F) worth Rs. 25 lakhs.
Keeping the above conditions in mind, the term life insurance cover required can be calculated with the following formula:
A*12 [(1-(1+B/100)^C / (1-(1+B/100)] + D - E + F - G
Therefore, the required term life insurance cover will be = [35,00012(1 – (1.05) ^20)/(1-1.05)] + 17,50,000 – 5,00,000 + 25,00,000 = Rs. 2,37,95,382. An ideal situation is to buy a plan with sum assured that is 10 times Mr. Johnny’s current annual income.
Conclusion
Most of the Indian population does not have a life insurance policy. This does not mean that you should not invest in one. In fact, you should invest in a life insurance plan as early as possible. The earlier you buy, the lesser would be the cost of premium. However, make sure that you invest in the right type of life insurance which suits your financial needs. If you want to purchase an online plan, compare multiple plans from different insurers and select the best one with the right price.
