You already know why life insurance is important. Atleast for common people like us who still aren’t rich enough to ignore it. After all, being underinsured and dying can be tragic for the dependents.
But one of the major problems that many insurance buyers face is finding out how much life insurance to buy.
There is a simple and methodical way to easily calculate how much life insurance to buy. But most people aren’t interested in putting in the required effort. They want easier answers. They just want someone to come and tell them what to do.
If that wasn’t enough, there are tons of insurance products ranging from term plans, endowment plans, moneyback plans, Ulips and what not. So people don’t know how to actually choose the right insurance product. Among the various options to save taxes, life insurance is also one of the most popular tax saving investments options in India. But still people don’t see insurance in the right perspective.
So let’s try to change the perspective a bit – let’s see how people’s life insurance requirements change with age.
This approach will hopefully provide a different and more relatable perspective on how to decide what the right life insurance cover is.
And no, picking a random figure like Rs 1 crore life insurance is not the right way to buy life insurance. J
So let’s move on… and begin when our hypothetical insurance buyer is a young man beginning his career.
Aged 20 to 25 – Unmarried
Assuming parents aren’t financially dependent on him, there aren’t any financial liabilities or responsibilities as such on the person. It’s possible that there might be an education loan. Insurance is needed only if there is a loan or possibility of parents becoming financially dependent in near future.
How much life insurance is needed?
Buying a small insurance plan (even if it isn’t needed immediately) can be a good idea as the premiums at a young age are very low. If the income is good enough, taking a larger cover is fine too as sooner or later (after marriage), responsibilities will increase and there would be a need to increase the cover anyhow.
Aged 25 to 30 – Married
Since the person is now married, there is a need to protect spouse’s financial interests. And if still not bought, this is the right and urgent time to take life insurance. The dependency logic of parents discussed above still stands. If a car or a home loan are also there, then that should also be accounted for when purchasing insurance.
How much life insurance is needed?
A term plan of up to atleast 10-15 times of annual income + outstanding loans might be a good idea if spouse working too. Being somewhat over-insured at this stage is fine too.
Aged 30 to mid 40s – Married with Kids
Life moves on and now with spouse and kids, there is a real need to protect their financial futures. An insurance cover should be such that it takes care of outstanding loans, regular expenses of the family for atleast 15-20 years, children’s higher education costs, etc. If there is an existing life cover, then it should be topped up or additional life insurance policy should be purchased.
How much life insurance is needed?
No shortcuts here. To correctly find out how much life cover is needed now, best to do it methodically using the method discussed here.
Aged late 40s to mid 50s: Earning Well + Kids in college
By now, the asset base would have grown substantially. Children would also be more or less on their way to become independent in a few years. Depending on how much existing savings are, it’s possible that there may not even be a need for insurance coverage as the existing assets will be more than sufficient to take care of just one risk – regular expenses of spouse in case of death of the insured person.
But since the insurance premiums won’t be too large when compared to the then income, it might make sense to continue with the existing cover for some more time. If there are any loans, then atleast that amount should be covered. It might also be a good idea to include a buffer amount for future medical expenses (for spouse) in insurance calculations too.
Aged 60 & Beyond
Mostly, the insurance need would not be there as the savings corpus would be much larger than what might be required to fund regular family (spouse’s) expenses in remaining years. Children it is assumed will be independent and not require any financial security.
So ideally, life insurance won’t be required anymore unless there is a need to leave a legacy behind.
As you can see, the life insurance needs of a person vary across different life stages.
Initially, it increases with increase in responsibilities and liabilities. But then eventually, it goes down and reaches a stage where it is not required at all.
Mostly, life insurance is not needed much beyond retirement. This is assuming enough money is saved up.
To summarize, the insurance amount should be big enough, at any given moment, to take care of the present and future financial needs of the dependents. That ways, a big insurance claim would help sort out the financial life of the dependents.
And since it’s possible to purchase a large life insurance cover at a very low premium using term plans, it also makes sense to purchase a large cover (even if it doesn’t seem to be required) early on as premiums would be low. Ofcourse there is the angle of insurance premium affordability. But if income is decent, taking a slightly larger cover is fine too.
Now there are several types of insurance products – or let’s say financial products that provide various levels of insurances. For example – term plans, endowment plans, moneyback plans, Ulips, etc.
And once you have decided the right life insurance cover amount, you have to choose a product that provides insurance. When it comes to high coverage and low premium, nothing beats a term plan. But still, a lot of people feel that they are better served by traditional insurance plans like moneyback, endowment plans, etc.
I have already written about how these products are structured and provide a mix of insurance and investment. You cannot expect to get a very big life cover at a very low premium.
Nevertheless, for a section of the savers’ community, who are conservative and aren’t too clear about the idea of ‘not mixing insurance and investments’, these products have been extremely popular.
Apart from these traditional insurance plans, the unit-linked insurance plans or Ulips are also available. Here again, one single product provides insurance with investments. So naturally, getting a very big cover without paying a large premium is next to impossible.
In Ulips, the sum assured is generally a multiple of annual premium paid and more importantly, you pay much more for the same life cover as compared to a Term plan. For example, a term plan of Rs 1 crore would cost you a few thousands every year, whereas a Ulip providing a cover of Rs 1 crore would cost you several lakhs! Yes…several lakhs!
So if you wish to go with the Ulips but cannot afford very high premiums, chances are that you will end up being under-insured. Which is extremely risky and can be disastrous for the family if you die in between.
Unfortunately, most Indians still buy life insurance to save taxes!
They are normally not concerned about ‘how much sum assured is actually needed’ and instead focus on premiums and taxes they can save.
How much income tax benefit can I get on life insurance premiums? – is the main question for many insurance buyers! J
The premiums that are paid for life insurance policy qualify for a tax deduction of up to Rs 1.5 lakh under Section 80C of the Income tax Act.
But if the sum assured of the policy is less than 10 times the annual premium, then the buyer will get a deduction on the premium of only up to 10% of the sum assured.
So if let’s say you buy an insurance policy of sum assured Rs 5 lakh at an annual premium of Rs 63,000, then only the 10% of the sum assured, i.e. Rs 50,000 will be tax deductible and not full Rs 63,000. So any premium that is in excess of the limit of 10% of Sum Assured) won’t qualify for the tax deduction under section 80C.
This is important because a lot of traditional plans like endowment, moneyback policies or Ulips have high premiums in comparison to sum assured. So one must be careful in this regard.
This was about tax saving while paying the premiums. But what about taxes on maturity or amount paid on death?
This is an important aspect that people forget about as they are blinded by their short-term thinking and the need to immediately gratify their urge to save some quick taxes.
Most people feel that the money they (or nominees) get in later years, on maturity or death from insurance policies is tax-free. This is true to an extent. But there is a small possibility that it might not be tax-free. Yes. It’s possible.
The death benefit, i.e. money paid to the nominee on death of policyholder is exempt from taxes.
But in case of survival of the policy holder, the maturity amount may not necessarily be tax-free. As per Section 10(10D) of the Income tax Act, if the premium paid is greater than 10% of the Sum Assured, then the maturity amount is taxable. So if the premium you pay is not more than 10% of the sum assured, then you are safe. Else the amount will be taxed on maturity.
This is why when you are buying life insurance, make sure you understand and more importantly, don’t ignore the taxation of the policy on maturity (as per exemption condition stated in Section 10(10D) of the IT Act.
The actual income tax benefit available to you under Section 80C or Section 10(10D) will vary for different policies. So it makes sense to spend some time to understand the income tax benefits on insurance plans, income tax benefits on term plans, income tax benefits on endowment plans, income tax benefits on single premium plans, income tax benefits on money back policies before you sign on the dotted line.
If you wish to really know how to buy the right life insurance policy, then first you need to clear your head about what life insurance’s real purpose is.
It is not there for tax saving. It is there to provide sufficient money to dependents to live their life comfortably and achieve their real life goals in your absence.
And there are several varieties of life insurance products that people can choose from ranging from simple term plans to endowment policies to Ulips. The ideal life insurance strategy for a person will depend on what stage they are in life, their financial goals, outstanding liabilities and responsibilities.
So make sure that you don’t pick random numbers to find the life insurance amount you need and chose the right insurance policy as soon as possible.
Remember, planning your insurance portfolio (both life and health) properly is very important if you don’t want to be at the mercy of luck in your life.