Ch. 5: How Much Life Insurance Do I Need

A life insurance policy can help you achieve a lot of goals in life. Some life insurance plans help you safeguard your family’s financial future, while others provide lifelong protection. Some help you save for your child’s future, while others offer a regular income in your retirement years, etc. Based on your needs and goals, you can select a life insurance plan that will be the most suitable for you and your family.

Now, after you zero down on the type of life plan you want to buy, one of the next and most important steps is to determine the cover amount. It is very crucial that you calculate and choose the appropriate coverage. Why? So that the money you or your family will get in the future is sufficient to cover the goal or purpose for which you buy the life insurance policy.

But, how do you decide how much cover to buy or how much money to invest under a life insurance policy? This is exactly what we will be discussing in this article. So, let’s dive right in!

➔ Term Insurance Plan

You buy a Term Insurance Plan to safeguard your family members who are financially dependent on you from any financial disruptions in your absence. This financial disruption is caused by the gap between what you will leave behind and what your family actually needs. You can calculate this gap by subtracting the amount you owe from the amount you own.

To find out how much amount you owe, you can consider the following aspects -

➔ Living Expenses Fund: Short-term expenses like basic needs, groceries, monthly bills, school fees, etc.
➔ Major Expenses Fund: Long-term goals like children’s education, wedding, etc.
➔ Major Liabilities Fund: Any loans/liabilities you’ve taken, like home loan, education loan, etc.

To calculate the amount you own, you can consider the existing funds you hold. This will include the money you have, cash at the bank, financial products you’ve invested in, like mutual funds, fixed deposits, equity shares, etc. All these funds will not be readily available - hence, you will have to multiply them by their appropriate risk factors. Here are the risk factors you can consider -

➔ Existing life insurance plans @ 100%
➔ Savings, cash, fixed deposits @ 100%
➔ Equity investments @ 50%
➔ Gold & residential property @ 0%
You would not want these assets to be liquidated for grocery purchases or repaying loans/liabilities - so, take them at zero value.
➔ Stock options @ 0%
These are high-risk investments - so, take them at zero value.

You must also account for inflation of 6-8% so that the cover amount will be sufficient for your loved ones in the future. In case you already have any other life insurance cover, you can subtract that amount from the term insurance cover amount you are planning to buy. After all this, the amount you will arrive at will be the gap you will need to fill through the term insurance plan.

A Whole Life Insurance Plan, as the name suggests, provides a life insurance cover for your entire life. It is one of the ways through which you can leave behind a financial legacy for your loved ones.

To understand how much cover amount to buy under a whole life insurance plan, you need to consider multiple aspects like -

• Your short-term expenses like school fees, monthly bills, etc.
• Your long-term goals like a child's higher education fees, wedding expenses, etc.
• Your loans and liabilities.
• Your assets, like cash at bank, fixed deposits, savings, investments, etc.
• Any existing life covers you hold, etc.

Choose a cover amount that will be sufficient to support your family financially in your absence. The amount should be adequate for both that and any legacy you intend to leave behind for your children. Lastly, in order to ensure that the amount you buy today is adequate for your family in the future, make sure you factor an inflation rate of 6-8% over this amount.

A Child Life Plan helps you cover several important milestones in your child’s life, like their education, wedding, etc. While buying this plan, you must ensure that you opt for a cover amount that will be sufficient to cover the expenses of the milestones you have in mind.

To calculate the right cover amount under a Child Life Plan you should -

• List down the milestones you wish to cover, whether it’s college fees, wedding expenses, etc.
• List of finances like your existing life insurance covers, gold, cash, etc., and liabilities like loans, etc. This will give you a better picture of how much you can spend from your own pocket.
• Examine the costs associated with each of the milestones you plan on covering and account for inflation of 6 to 8% for at least 12 to 15 years since the milestones will occur at later stages.

An Endowment Plan is an insurance cum savings plan. It provides protection to your family as well as helps in saving for your long-term goals such as retirement, children’s education, purchasing a house, and so on. It will pay a guaranteed lump sum amount when the policy matures. In case you pass away while the policy is active, the payout will be made to your nominee.

While buying an Endowment Plan, you must figure out your financial goals and estimate the money you and your family will require for these goals. The cover amount you choose should be enough to attain the goal for which you are buying the plan. For instance, say you think you will need Rs. 3 Crores for your daughter’s wedding after 20-25 years. In this case, you can buy an Endowment Plan with a cover amount of Rs. 3 Crores for a duration of 25 years.

While deciding the cover amount, make sure you also consider other aspects like any existing insurance plan you may hold, your assets, liabilities, etc. And factor in inflation of 6 to 8% over this amount for a period of at least 12-15 years.

There are some endowment plans that do not allow you to select the cover amount. Instead, you are given the option of choosing the premium amount, and the cover amount will be a multiple of the annual premium (investment amount) you pay. Hence, while deciding on the amount you will invest, keep in mind your goal of investing in the Endowment Plan, and thoroughly read the brochure and policy wordings before going ahead.

A Money Back plan is also an insurance cum investment plan. It offers periodic payouts as per the policy schedule, ensuring a steady source of income to help you meet expenses at different stages of your life.

Now, before you buy a Money Back plan, you will have to define the financial goals you want the plan to help you achieve. Why? So that you opt for an amount that will cover the goals you have envisioned. You will have to estimate the payouts you will require in the future to achieve the goals you have in mind. The payouts you calculate should cover key milestones like your EMIs for a vehicle/house you purchased, your retirement, and so on. While you are at it, don’t forget to take into account inflation of at least 6 to 8%.

Just like Endowment Plans, not all Money Back Plans allow you to choose the cover amount. Under some Money Back plans, the insurance company gives you an option to decide the premium amount. And, the cover amount under the plan will be a multiple of the annual premium (investment amount) you pay. So, if you are planning to invest in such a plan, keep your investment goal in mind while deciding how much money to invest in the plan. Also, make sure you carefully read the policy wordings and brochure before finalising the plan.

A Unit Linked Insurance Plan, or ULIP, is a blend of insurance and stock market-linked investment. It provides a life cover as well as gives you an opportunity to invest in several stock market instruments so that you can achieve your long-term financial goals.

The cover amount under a ULIP will be paid to your family in case of your unfortunate demise during the policy tenure. However, as discussed above, this cover amount may not be sufficient for your family when you’re not around anymore. That is why you should look at a Unit Linked Insurance Plan purely as an investment product - and buy a term plan for your family so that they will have adequate cover in your absence.

A Unit Linked Insurance Plan is a great financial instrument to consider if you want to build wealth for your long-term financial goals. It has the potential to generate very high returns over a long period of time. If you are planning to invest in a ULIP, ensure you invest an amount that will fit your current budget as well as give you enough returns for the long-term goals you want to achieve.

An Annuity Plan is a type of retirement plan that will provide you with a regular income in your post-retirement years.

Basically, you are required to make the premium payment/s under the Annuity Plan which gets accumulated into a fund. This fund is then converted into an annuity, i.e., a steady stream of income. Based on the annuity rate determined by the insurance company and the funds accumulated under the annuity plan, your annuity payouts will be determined. This means that the more money you invest under the plan, the greater annuity or income you will receive on a regular basis after you retire.

Remember, there is no ‘sum assured’ or ‘cover amount’ in an Annuity Plan. You are only offered periodic payments in your post-retirement life - depending on the money you invest in the plan. So, while buying the Annuity Plan, you will have to determine how much annuity (income) you want to receive throughout your retirement years and then make the premium payment/s under the plan accordingly.

Under a Pension Accumulation Plan, you can invest your savings in a systematic manner to accumulate a retirement fund.

While deciding how much to invest in a Pension Accumulation Plan, one of the most important things you must keep in mind is that the amount you will receive will be for your post-retirement needs - so that you can live a comfortable life after you retire without depending on anyone. This should be the primary goal behind buying a Pension Accumulation Plan. You can estimate the amount of money you will need after you retire, and then accordingly decide how much money to invest under this plan. While deciding the amount, make sure you also factor in inflation of around 6 to 8%.

Another important thing you must be aware of while deciding how much money to invest in a Pension Accumulation Plan is that you cannot use the entire payout you’ll get under it as per your wish. The money you receive will have to be used in accordance with IRDAI guidelines. Basically, you have three options when you receive the payout under a Pension Accumulation Plan -

• You can withdraw 60% of the accumulated fund (also known as ‘commutation’ in technical terms) and invest the remaining 40% in a single-premium annuity plan.
  Read about single-premium annuity plans in detail here
• You can invest 100% of the corpus net of withdrawals, if any, in a single-premium annuity plan offered by the same insurance company.
• You can invest 50% of the corpus net of withdrawals, if any, in a single-premium annuity plan offered by the same insurer. And, the remaining 50% can be invested in a single-premium annuity plan offered by another insurer.

Make sure you’re aware of these conditions before investing in a Pension Accumulation Plan.

This brings us to the end of this article. We hope you now have enough clarity on how much cover amount you must choose or how much amount you must invest under each type of life insurance plan. Remember, having an inadequate cover is equal to having no cover at all. So, make sure you carefully calculate the cover amount under the life insurance plan you are planning to buy - to avoid any hassles in the future.