INSURANCE:

How Much Life Insurance Do I Need?  : A Step-by-step Guide

You want to have:

“peace of mind”

knowing that if something were to happen to you tomorrow, your loved ones would be taken care of financially.

That’s why we created this guide.

Let’s begin!

 

Personal Budget income

Let’s talk about one of the most important decisions you’ll ever make as an individual.

This decision is not a fun, happy topic, and many people don’t enjoy thinking about it.

However, this should be on your mind if you want your family financially protected if anything happened to you.

One of the most crucial components for living life successfully is making sure that those closest are taken care of after passing away.

Loved ones can include spouse/children/parents.

Some feel comfortable doing so (in order) by purchasing enough life coverage.

But, the question is: how much coverage do I need?

InsuranceQuestion

Let’s find out the right coverage through these easy steps.

Use the accompanying workbook that makes following the steps SUPER easy!

The method assumes you want your family to maintain the current lifestyle. Also, this method helps preserve the properties and not sell off properties to make a living.

READY? Let’s jump right into the steps!

Step 1. Calculate your family’s future expenses.

List all the monthly expenses of your family. This will help you know how much money they are spending each month on groceries, utility bills, rent, etc.

Why?

This is the amount that your family will have to spend whether you are there or not. So, it’s important to know this amount.

Use the ‘Monthly Expenses‘ part in the ‘Future Expenses‘ sheet to list all the expenses.

Life Insurance Workbook Monthly Expenses

Add up all those items together for an average sum per month.

To keep things simple for the next steps, multiply the monthly expenses by 12 to get the Annual Expenses.

Annual Expenses = Monthly expenses x 12
FutureExpenses2 Copy

What we just calculated is the present value of expenses. This has to be converted to future household expenses.

How?

Let’s spend a little time here.

Depending on where you are in your life stage, you may have different types of expenses.

For example:

If you are married with small kids and if something happens to you, the family needs to take care of itself for a longer time.

The older you are, you may have cleared some of the loans and may have lower expenses.

So, here is a guideline to multiply your annual expenses depending on your age.

Age (years)
25-35
36-45
46-55
Expense Factor
20
15
10
table Expense Factor

Now, calculate the amount of your Future expenses by multiplying your yearly expenses by the Expense Factor.

Future Expenses Amount = Annual expenses x Expense factor.
FutureExpenses2 Copy 2

Step 2. List your outstanding loan amount.

Next, list and calculate the total of any of the liabilities that need to be paid off.

The outstanding debt is the total amount you owe on your personal loan, home loan, car loan, and any other debt.

Why?

This would help you know how much money needs to be paid immediately if something unfortunate happened. If your family has at least this much money, all the debts can be taken care of.

It means the house, car and other things can be retained as the family will have the money to clear the outstanding.

Use the ‘Outstanding Debts‘ sheet in the workbook to list all the loans and debts.

Think how much outstanding you have on: 

  • Personal loans: Include all the money you may have borrowed from the banks as personal loans.
  • Auto/Car loans: Consider listing all the outstanding car loans and/or two-wheeler loans.
  • Housing loan: Include plot loans and outstanding home loan amount.
  • Student loan: List, if any.
  • Credit card outstanding: If it is significant enough, make sure you list it. If you have a loan on a credit card, list it too.
  • Others: List any other loans you may have taken. You may have taken money from family/friends; list them here.
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Add up each of the outstanding amounts to get the Total Outstanding Debts.

3. Think about future financial goals

If you have done your financial planning, you will have a list of financial goals.

Even otherwise, this is the time to think about how much you plan to save for each of the future (or current) goals.

These may include:

  • Children’s marriage
  • Children’s education
  • Retirement fund for spouse (which is sufficient for them)
  • Other financial goals

Think how much you are willing to spend on each of those if they are due today. Enter the above amount under ‘Today’s Amount’ in the ‘Future Financial Goals’ sheet.

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Consider inflation: You have to account for inflation because your future savings will be worth less than what they are today.

Use a simple calculator to get the inflation-adjusted amount for each of your financial goals.

Let’s say you need to have Rs.15,000,00 (present value) for your kids’ education. And your kid needs this amount after 16 years.

Using the inflation calculator, you get an inflation-adjusted amount of Rs. 32,74,312 at a 5% inflation rate. This is the amount they need by the time they are ready for college.

So, enter this amount in the next column under the ‘Inflation Adjusted Amount’.

Life Insurance Workbook Future Expenses

Add up all the adjusted future goal amounts to get Future Goals Amount.

4. Consider the savings and current investments

List down how much you have in liquid assets:

  • Cash
  • Mutual Funds
  • Shares
  • Bonds
  • Investments in Gold
  • Fixed Deposits (FD)
  • Provident Fund
  • Money lent to friends/family
  • Any others
Life Insurance Workbook Future Expenses

Sum all the above items, and you’ll get a Total of Cash and Investments.

Why?

This is the money already available for the family in case of the untimely demise of the insured.

5. Consider the existing life insurance coverage

You can look at the existing life insurance premium you are paying and the life coverage you already have through those policies taken.

Look for the insured amount on these policies and list them.

Why?

Knowing how much you are already covered will help you get only the additional life coverage you REALLY need.

Life Insurance Workbook  Future Expenses

Add all the insured amount to get the Total of Current Coverage.

PRO-TIP

You may want to know if it is okay to consider the insurance provided by the employer here.

While technically you can, my personal opinion is not to consider.

The reason is simple:

Such coverage is only applicable as long as you are employed.

It’s possible:

  • at some point, you may want to leave the job and start a business, or
  • you may be in between the jobs, and something happens

In such cases, you are not adequately covered. So it’s best to look at life insurance options that will be in place for the rest of your lifetime.

MY STORY

I did take my first term life insurance when I was 26 and single. I had opted for a life coverage of one crore as my mother was the sole dependent.

At the time of marriage, I did not increase the coverage as my wife was also earning. It was my call just based on a gut feel, not a suggestion for you. 

However, soon after my daughter was born, I decided to increase my life insurance need and went for another policy. I considered existing coverage at that time and went for the additional coverage needed.

Bottom line: Life insurance needs to be revisited every 5 years or when there is a big life event. This will help you protect yourself and your family sufficiently.

Step 6. Calculate how much insurance you need:

Great job so far!

This step is effortless and SUPER easy as you just have to do addition and subtraction.

You have to add:

  1. Your family’s FUTURE EXPENSES
  2. The TOTAL OUTSTANDING DEBTS that you owe at the moment
  3. The FUTURE GOALS AMOUNT that you plan to save

And, then subtract:

  1. How much CASH & INVESTMENTS you have that are liquid in nature
  2. How much TOTAL CURRENT COVERAGE on the life you have today

and then…

you get your SUM INSURANCE NEEDED which is where we started to find how much life insurance I need!

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Quite straightforward. Isn’t it?!

Go ahead and grab the workbook, and you are all set to calculate yourself.

Life Insurance Workbook

Find the templates you will need to:

  • Capture Future Expenses
  • List Outstanding Debts
  • Capture Future Financial Goals
  • List Savings and Investments
  • List Existing Insurances
  • Calculate Life Coverage Needed

FAQs on Life Insurance

How much life insurance do I need as a rule of thumb?

One way to assess how much life insurance is needed is by calculating the number of times that your annual income should be multiplied.  

In most cases, a good rule of thumb is 20 times your annual income. Some suggest 10 times the annual income, but with the ever-increasing cost of everything, 20 may be better. 

For example, if you make Rs. 7 lakhs per year, then ideally, you would want life insurance cover for Rs. 1.4 crores. 

Alternatively, suppose that you are married with two children, age 12 and 15, and your spouse brings in Rs.5 lakhs per year income. Realistically look at what your family requires in life insurance coverages might be 5-8 times. This would be applied based on earnings from the person who earns the highest amount.

As you can see, it is really a bad idea to go by a multiple to find life cover than understanding your exact financial situation and arrive at how much life insurance cover you need.

Going solely by this multiples method (thumb rules) to know how much life insurance coverage may get to a situation wherein you either have too little life cover or too much insurance.

What are the different types of life insurance policies?

There are several types of life insurance policies available in India by most insurance companies for us. They are

  • Term life insurance
  • Term life insurance with return of premium
  • Endowment plans
  • Moneyback policy
  • Child Insurance Plans
  • Unit Linked Insurance Plans
  • Whole life insurance
  • Group life insurance
  • Retirement Plans

Many of these combine life cover with investments.

The best way to buy life insurance is to go for pure insurance, “Term Life Insurance”. Keep the investment part separate through stocks, FD, mutual funds and others.

Which are the different life insurance riders available?

After you determine insurance needs, certain riders are on top of it and help in a certain situation. Here are the most common riders offered by life insurance companies:

  • Accidental death benefit (ADB): provides additional cover if the death is due to an accident
  • Critical illness: helps you cover specific health-related expenses
  • Waiver of premium: you need not have to continue to pay the premiums if a specific incident happens, like a permanent disability
  • Income benefit: provides a specific annual income for a few years for the family after the loss of human life
When should you not get life insurance cover?

Life insurance provides financial protection for your family in the unfortunate event of your death.

So, if you are:

  • debt free and
  • you have enough money and investments that are sufficient to take care of your dependents

then you need not take life insurance.

Can a life insurance company refuse to pay the sum assured?

It is possible that the life insurance company refuse to pay the sum assured. It may happen depending on the situation.

You might read through the life insurance policy and find terms that state when they can refuse to pay. If it does, then in those situations the company need not pay the amount of life insurance.

In most cases, an insurance company will have something called a guideline sentence that states they can deny death claims if you are refusing treatment or neglecting your health during treatment.

Is life insurance a waste of money?

It may not be beneficial for you if to buy life insurance if you are financially self-sufficient and:

  • you do not have dependents or
  • any other obligations that would cause a problem for them

Because a life insurance policy typically has two main aspects to it:

  • the death benefit
  • the income replacement

While there is no replacement for human life value, the death benefit will pay out the family in the event of your unexpected passing for taking care of financial aspects.

The income replacement covers living expenses during the transition period and preferably provides for future financial needs as well and gives them financial freedom.

If there is enough money to take care of dependents or none depend on you, then you may choose not to get an insurance policy.

Who needs life insurance the most?

It’s an excellent idea to get life insurance for your family if you’re the primary breadwinner and have dependents, but it’s also worth considering buying it if you’re still young.

Life insurance need is critical because financial hardship that comes from sudden death can be an impoverishing experience for any family. So, insurance, particularly life insurance, is very important.

Why permanent life insurance is a bad investment?

A permanent life insurance policy (a.k.a “whole life insurance”) does not give you any interest earnings on the money that you pay into it as other investments do.

And if you’re investing in whole life plans when a traditional term plan provides equivalent coverage at a lower price, then your whole life plan defeats the purpose of having insurance for many people – safety and security through guaranteed lifetime protection at affordable rates.

There are some circumstances where a whole life policy may be useful when you have dependents for a longer period of time or for your entire lifetime. Example: a specially-abled child. In such a case, it helps as the whole life policies provide coverage till the policyholder’s age is 99 years.

But most likely, whole life policies represent higher-cost and no added benefits.

Conclusion

You deserve a life that is filled with joy and happiness.

That’s why it’s so important to take the initiative now and plan for your future.

This includes getting enough insurance coverage in place to protect you and your family financially if something were ever to happen.

Hope you found this guide and workbook useful.

Let me know your thoughts in the comments.

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