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How much insurance cover do you need ?

If you are an earning member of your family, and your family members are financially dependant on you, you do need life insurance.
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 familys present needs are Rs 30,000 p.m. The extent of life insurance for its earning members should be such that interest income from the sum assured can meet the familys monthly expenses of Rs 30,000.

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.
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 simple rules

Life insurance policy can protect you from financial difficulties and provides assurance that your loved ones will be taken care of in the event of any mishap.
One should know how to estimate the appropriate value of life insurance you need.
As ones 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. A portfolio manager is the person who can advise how much insurance cover you need.

There are several simple methods available to broadly estimate your life insurance needs. Some simple rules are:

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 ones 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.

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, childs education, etc.

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.

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 persons death. Under the family needs approach, one has to divide his familys 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
  • Retired
  • The needs decline once children grow up and get settled. No major financial problems
  • Strong assets base, surpassing the financial needs

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 Retired stage.

The maximum need for life insurance arises during the mid-phase, when one is married and has children. One should take the maximum insurance cover as this would become his corpus at the maturity and unfortunately in case of any mishap the insurance money will be the major source of income for his family in his absence.