How much Life Insurance you need

Insurance plays a pivotal role in safeguarding an individual’s financial well-being against unexpected life events. Determining the right amount of coverage for various insurance types, such as life insurance, medical insurance, critical illness cover, and disability insurance, requires a thoughtful analysis of personal circumstances and potential risks. Let us look at Life insurance today. Most frequently asked question is how much life Insurance I need. Here’s a concise guide to help you calculate your insurance needs effectively…

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Life Insurance

Life insurance is designed to provide financial support to your loved ones in the event of your untimely demise. To calculate the right coverage amount, consider the following factors:

• Income Replacement: Estimate the number of years your dependents would need financial support if you were to pass away. Multiply your annual income by the number of years and add any additional expenses like mortgage payments or college tuition.
• Outstanding Debts: Include any outstanding debts such as mortgages, loans, and credit card debts. This will prevent your family from inheriting these financial burdens.
• Future Expenses: Account for future expenses, such as your children’s education and your spouse’s retirement, to ensure they’re adequately funded.
• Existing Savings: Subtract your existing savings and investments from the total estimated financial needs to determine the required life insurance coverage.

Life Insurance Calculation with example

We will take example of calculating life insurance need using future expenses approach. This will help you calculate insurance need so that all the future expenses of your family are taken care. There are various expenses you need to take care. Let us look at them one by one.

Taking care of family’s regular expenses in your absence

First of all you would need to know what are your monthly expenses. You can refer my article on how to calculate expenses with free excel tool. Since you are calculating life insurance needs, you need to consider expenses that family would need minus yours. Let us say this comes as 1 Lac per month.

Next would be deciding how much time family would need to stand on its own feet in your absence. Generally 15 year period is good enough but you will need to consider age of your children as how long they would need financial support. Support you have child of just 2 years. May be family needs support till its graduation and that could be 20 years. Suppose you are in late 40s or early 50s and children are nearing their education completion, you may need a shorter period. For this example, let us say its 15 years.

So first part in this calculation is multiplying per month expenses by number of months. So 1 Lac X 15 Years X 12 months in a year = 180 Lacs or 1.8 Crore. Here we are not considering inflation of expenses as it is assumed that family would work with some financial planner or advisor to invest money and get returns that minimally beat inflation. This amount will take care of family’s regular expenses.

Taking care of family’s goals in your absence

Next would be to look at necessary goals of family that you would like them to avail even in your absence. These could be child graduation, post graduation, marriage, any foreign vacation (not really necessity) or events that would need some lumpsum amount.

You should make list and put amount that you would need as of now for that event. What I mean is that if as of today, expenses for doing Engineering degree from a good college is say 25 Lac then you need to consider that amount. Again no need to consider inflation and think how much it would be when your son or daughter gets there. This is because underlying assumption is this amount will also grow minimally inflation.

Let us say this amount for you comes at 1 Cr.

Taking care of spouse retirement expenses

If you have spouse and if she is not earning then you will need to have some provision for her retirement / old age corpus. Although this will change case to case basis, you may start with 50% of expenses that you calculated above and again use similar formula based on life expectance of spouse post initial 15 years.

So 50 Thousand X 25 Years X 12 months in a year = 150 Lacs or 1.5 Crore. If you take help from financial advisor, this amount can come to much lesser. This is because with more than 15 years to retirement, you can invest more in equity and get better returns. This will reduce need of such high initial amount. But for now, let us consider it as 1.5 Cr

Keeping buffer for Medical surprises

Last but not the least, it is good to have some provision for major medical issues in family. Though amount depends on individual income class, for middle or upper middle class, I would say Rs 10 lac per family member is what one can consider as reasonable. So if you have three family members to take care of in your absence (Wife and two children) then 3 X 10 Lac = 30 Lac

Close the loans

Make sure you also consider loans that are currently ongoing. Suppose you have housing loan with balance principal of 35 Lacs and car loan of 5 Lacs. So you need to include these in calculation. If any loan (generally housing loan) is already covered against insurance then you can skip this.

Time to get total to address all family needs

If you add all above numbers, you will get total needs of family.

Family regular expenses	1.8 Cr
Family goal based expenses	1.0 Cr
Retirement corpus for Spouse	1.5 Cr
Medical Expenses provision	0.3 Cr
Outstanding loans	0.4 Cr
Total Life Insurance Need	5.0 Cr

Don’t forget your assets, savings

Next part is get all your financial assets. Total up your EPF, PPF, Mutual Fund investments, FDs etc. Let us say they come up to 1.6 Cr in this case. Since this amount is already available to family, you should reduce life insurance need by this amount.

So final life insurance need = 5.0 Cr need – 1.6 Cr financial assets = 3.4 Cr

Point to consider during Life Insurance Calculation

Most important point is to be realistic with expectations. Your expenses and goals should be something achievable with your means. For example, let us say getting MBBS degree in private college needs overall 1 Cr. Having this goal for your child is good but you need to ask question that is it financially manageable if you are alive and earning. If you can not achieve particular goal if you are alive till that goal comes then that is unrealistic goal. Don’t consider Life insurance like a lottery that family will enjoy lavish life after you and take policy of something very unrealistic. You will spend un necessary high premium when they is no such need.

Why inflation is not considered in this calculation

As we all know value of rupees reduces with time. What we can buy in 1Lac currently will need say 1.05Lac next year, 1.1 Lac subsequent year and so on. However we have not considered inflation here. My reasoning is that amount family will receive will be invested such that it will be able to beat inflation.

Second concern could be this calculation holds valid as of time of taking insurance but event could happen few years down the line and we will still get same amount. Say 3.4 Cr. Let is assume insurance is taken at age of 40 and death of insured happens at 50. So in normal case, we may feel amount is not sufficient now. However if you look practically, in these 10 years person would have built lot of more assets and repaid loan to some extent. This will help offset and keep amount reasonably close to what was insured.

Having said this, it is always good to review your life insurance needs regularly at least once in 3 to 5 years or when a major event like birth of new child, loss of family member etc happens to see if any change is needed.

Types of Life Insurance Products

These policies can be categorised in different types based on how benefit is calculated and paid.

1. Term Insurance

This is pure risk cover product and pays benefit only if policy holder dies during the period of insurance. No investment element here. So most cheapest option. Best for investors and worse for Insurance agents as commission is least.

Since natural human mind does not like to put money and not to get anything on maturity, there is variant of Term Insurance. It is called Term Insurance with Return of premium. In this case premium is little higher than pure Term plan but policy holder gets all premium paid back if he / she survives insurance period. General calculation will show return on extra premium is between 4-5 %. So not really worth it. Better to invest extra premium somewhere else.

2. Endowment

It is investment cum insurance product. If policy holder survives, he/she will get investment part of overall premium plus returns on that. Returns are often called as Bonus and declared every year. There are multiple variants of endowment policies based on tenure, type of bonus, periodic payout options (also called as Money Back Policies). Typically but not always premium is Insurance cover divided by number of years. So say 25 Lac insurance for 25 years would be near about 1 Lac ( 25 Lac divided by 25 years). Typical return are around 5 to 5.5%. Since commission in these policies is highest, most common mis sold insurance product.

3. Whole Life Insurance

This is also investment cum insurance Product. As name suggests, policy holder is ensured for entire life. Premium is generally paid for limited years or in some case entire period. Nominee will get the sum assured and bonus if any. Earlier it was used for passing on wealth to next generation in tax efficient manner but with abolition of estate duty, it has lost the shin.

4. Unit Linked Insurance (ULIP)

This too is investment cum insurance product. However difference over above products, is policy holder is allowed to decide how investment portion is invested. Insurance company will deduct insurance and other charges from premium and will invest rest of amount in market linked funds. Generally policy holder can decide which funds to invest and free to do changes every year.

This product is currently competing with Mutual funds. Let us take example of say 25,000/ month premium for a ULIP for say insurance cover of 1 Cr. One can take 1 Cr Term insurance say around 1000/month and invest rest 24,000/- in choice of mutual fund. Since both will invest in market linked instruments of investor’s choice, one needs to carefully evaluate which is better option for policy holder.

ULIP will have 5 years lock in. Movement between schemes of same insurance company is easy and without tax implications. In Mutual fund, there will be tax implication in switch but one will have freedom to move from one AMC to other (Say HDFC to ICICI). This is not possible in ULIP as you will need to chose schemes of same insurance company. Again mutual fund are more transparent in investment and charges over ULIPs. One key benefit in ULIP over Mutual Funds is tax benefit. If some assured is at least 10 times annual premium then maturity amount is exempt from tax. Capital Gain tax is application in Mutual Funds.

My Choice

This has been no brainer. Keep insurance and investment separate and would go for Term Insurance. As far as selecting to buy it from which company, I would go one with lowest premium. Once policy completes 3 years, no insurance company will be allowed to reject claim as per IRDA guidelines. So no real need to check for brand here.

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Also note it is essential to periodically review and adjust your insurance coverage whenever there are major changes in your life. Consulting with insurance professionals and financial advisors can provide valuable insights tailored to your individual needs. But if your are a DIY financial person, hope this article gave you some useful insights.