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Insurance requirements change with Age & Tax Benefits on Life Insurance

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.

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Confused with Different Types of Term Plans? Here is How to choose the Right Term Plan

When it comes to buying life insurance for yourself, the best option is to go for a simple term insurance policy. Period.

With that aside, your next question would be – which is the best term insurance plan to buy?

The answer isn’t simple anymore.

Earlier, term plans came in just one version, i.e. they paid lumpsum (sum assured) at the death of the insured person.

But now, the insurance companies have introduced many variations of these term life insurance plans.

Majorly, these variations give the policyholder different options to decide how the total sum assured is paid out to the nominee in case of policyholder’s death.

But think about it…

Why would you anyone even think about the other versions of the simple term plan?

It will become clear as I explain it in the next sections.

You will realize that just buying a Rs 1 crore term plan or some other plan is not enough. You really need to think hard about how the money will be handled after you and accordingly, choose the right version of the term plan.

So let’s move on…

Types of Term Insurance Policies in India

Let’s see how these term plan varieties differ from each other.

1 – Term Plan with Lumpsum Payout

This is the most basic version.

Let’s say you buy a term plan of Rs 1 crore. In case you die during the policy tenure, your nominee will be paid the full amount of Rs 1 crore in one go. Nothing more, nothing less.

There is nothing much to explain about this option.

The other remaining options of the term insurance plans in India take the staggered route to money payout.

2 – Term Plan with Fixed Monthly Payout

In this plan, there is no lumpsum payout. Instead, the sum assured is utilized to provide a regular monthly income to the nominee for a fixed number of years.

For example – You take Rs 1 Crore term plan. Now if you die within the policy tenure, then the sum assured is paid out as a monthly income of Rs 83,333 for next 10 years (i.e. Rs 83,333 x 12 x 10 = Rs 1 Cr).

This monthly income can either be fixed (as above) or can also be increasing one.

3 – Term Plan with Lumpsum + Fixed Monthly Payout

In this plan, a percentage of the sum assured is paid out at the time of death. The remaining amount is paid as a monthly income, which is a fixed percentage of the remaining sum assured for a fixed number of years.

For example – You take Rs 1 Crore term plan. Now if you die within the policy tenure, a percentage of the sum assured let’s say 40% (i.e. Rs 40 lac) is paid out immediately. The remaining 60% (or Rs 60 lac) is paid out as monthly income of Rs 50,000 for next 10 years (i.e. Rs 50,000 x 12 x 10).

4 – Term Plan with Lumpsum + Increasing Monthly Payout

In this plan, a percentage of the sum assured is paid out at the time of death. The remaining amount is paid as a monthly income, which increases at a pre-determined percentage on a simple interest basis on every policy/death anniversary for a fixed number of years.

For example – You take Rs 1 crore term plan. Now if you die within the policy tenure, a percentage of the sum assured let’s say 40% (i.e. Rs 40 lac) is paid out immediately. The remaining is paid out as a starting monthly income of Rs 50,000 which increases by let’s say 10% every year. So next year, the monthly payout will be Rs 55,000 and so on. Generally, the total payout in this version is more than the original sum assured.

In both the above options (lumpsum + fixed monthly payout and lumpsum + increasing monthly payout), the lumpsum % can be different as per insurer’s or policyholder’s choice. There are many plans that even pay 100% of the sum assured upfront and additionally pay a monthly income (fixed or increasing) to the nominee.

For example – You take Rs 1 crore term plan. Now if you die within the policy tenure, full Rs 1 crore is paid out to the nominee immediately. In addition, a monthly payout of Rs 50,000 is made for the next 10 years. The total payout in this version is more than the original sum assured. To be exact, it is Rs 1 crore + Rs 60 lac (Rs 50,000 x 12 x 10).

These are the major versions of the term plans that are available these days.

Now let me address the point that I raised earlier – Why would anyone even think about the other versions of the simple term plan where the payout is staggered?

Quite often, the nominees lack proper personal financial knowledge when it comes to handling large sums of money. So once they receive a large amount, they may be unable to properly manage the sudden increase in wealth and end up losing it by listening to the wrong people.

So in order to overcome this concern, many insurance companies came up with various other payout options.

This way, the nominees receive a part of the amount as lumpsum to take care of immediate concerns (like closing all loans, other big expenses in the near term). The remaining amount is paid as monthly payments over a pre-decided number of years, to replicate the regular income pattern and help smoothen the life of the nominees.

That is the major reason for the launch of these different versions.

So depending on the ability of your nominees to handle money, you should pick the adequate option:

  • If you are sure your nominee is well-versed in personal finance, then you can go for the full lumpsum payout term plan.
  • If you feel the nominee is better off not having a large amount suddenly (due to any reason you think), then you can go for the staggered-payout term plans.
  • If you feel that if your sudden death will result in financial chaos (due to outstanding loan or planned big expenses in the near term), then you can take the term plan that pays a % as lumpsum and remaining as monthly income (if you feel the nominee will be unable to handle money properly).

As you might be feeling right now, there are cases where opting for the staggered payout option actually makes sense.

Ofcourse from a purely financial perspective, it’s best to take the lumpsum and invest it efficiently and try to generate income from it for the nominees. But all decisions cannot be taken just from mathematical perspectives.

Do premiums vary for different Term Plans?

Yes of course.

Different versions of the term plan have different premiums.

To give you an idea, here is a snapshot of the various versions, with their benefits and approximate annual premiums for a 30-year old, non-smoking male living in a metro city and buying a 30-year term plan:

Types Term Insurance Plans India Premiums

The first one is the normal term plan that you know of – pays lumpsum amount (equal to the sum assured at the death of policyholder). Others are different plans paying different monthly incomes which is either fixed or increasing each year.

There are several term insurance premium calculator available online. It’s best to check out the premiums for different types of policies for yourself.

The actual premium that you will have to pay will depend on a variety of factors. If you take a policy for a longer tenure, then it will cost more. In general, shorter the policy term, lower will be the premiums. To choose the right policy term, do read what should be the ideal term insurance policy term?

And I almost forgot telling you about another variety of Term Plans that has been pitched by a lot of agents in recent times – Return of Premium Term Plan.

Is Return of Premium Term Plan Good?

A lot of people who wish to buy term plans have this feeling that since they will survive the policy period, the premium which they are paying will be wasted.

For these people, insurance companies have come up with a term plan where the premium paid over the course of policy tenure is returned back if the person survives.

At the face of it, this seems like a good idea. And this policy did address the concerns of people who thought that the term plans are a waste of money.

But if you deep dive a bit, things aren’t that great. Such policies have premiums much higher than the normal term plans.

If we were to compare a plain term plan (that only pays lumpsum amount) with a term plan (that also only pays lumpsum) with the return of premium option, then the premiums are Rs 9717 for a plain term plan and Rs 24,968 for return-of-premium term plan.

These premiums are for a 30-year old, non-smoking male buying a 30-year term plan living in a metro city.

Let’s compare these two plans a bit more.

The total premium paid is Rs 2.91 lac for plain term plan (Rs 9717 annually x 30 years) and Rs 7.49 lac for return-of-premium term plan (Rs 24,968 annually x 30 years).

In case of death during policy tenure, the nominee gets Rs 1 crore in both cases (as the sum assured is same).

But in case of survival, things change.

In case of plain term plan, you get back nothing – that is, you don’t get back Rs 2.91 lac. On the other hand in case of Return-of-Premium Term Plan, you get back your Rs 7.49 lac.

You may again feel that the return of premium plan is better. But remember that you are paying a high premium for that.

The difference between the annual premium of the two plans is a little more than Rs 15,000 (= Rs 24,968 – Rs 9717).

If you invest this difference amount of Rs 15,000 every year at just 8%, then at the end of 30 years you will have about Rs 18-19 lac. Compare this with the amount the return-of-premium offers you at the end, i.e. Rs 7.49 lac.

So the obvious conclusion is that it’s better to not purchase a return of premium term plan. You are better off with either a simple term plan (or some of its variants that offer monthly income).

Finally…

Term insurance is still the best insurance that you should be buying for covering your life. The traditional ones like endowment, moneyback insurance plans are best avoided.

But since term plans also come in various shapes in sizes, its natural to ask which is the best term insurance plan for you?

As mentioned earlier, the choice of the term plan variety is dependent a lot on how capable do you feel your nominees are in managing money. If they are financially aware, going for a lumpsum payout is best. If they aren’t and you want to provide them with a regular income for a few years after you die, then take the lumpsum + monthly income payout option. Or you can have the best of both worlds by taking two policies combining the two approaches.


Answers to 20 Important Questions about Term Life Insurance

 

20 questions Term Life Insurance

Term life insurance is the most basic form of life insurance. And I can safely say that it’s the most effective and the best form of insurance.

Why?

Because it gives you a very high insurance coverage (sum assured) at a very low premium. It’s perfect!

Many of you know about the benefits of choosing a term plan when compared to the whole menu of the available life insurance varieties. But this post is for those who are still not sure whether buying term insurance makes sense or not.

So here are answers to a few common questions that people have about term insurance plans.

Q1: How does Term Plan work?

A1: The buyer buys a term plan for a specified tenure. Let’s say 30 years. Now if the premiums are being paid regularly, then if the insured person dies between today and the 30th year, the insurance company will pay the sum assured to the nominee. If the person does not die during the tenure of the policy, nothing will be paid to either the insured person or the nominee.

Q2: Most people won’t die. So money paid in term plan premiums will be lost?

A2: Wrong way to look at it. Term plans are incredibly cheap. You can get a term plan of Rs 1 crore for just Rs 10,000 or even lower. On the other hand, a traditional insurance plan (like moneyback and endowment plans) can cost about Rs 25,000 for just a Rs 5 lac cover. The first thing to note is that this doesn’t make sense when you compare it with term insurance premiums. Second is that if you die, a payout of Rs 1 crore is more useful for your family than a payout of Rs 5 lac. Agreed that you won’t get anything back in term plan if you live. But what if you want to buy a Rs 1 crore cover using a traditional plan? Try to find it out. The premium will be so huge that you might not even be capable of paying it. So term plan allows you to give bigger protection to your family at a much lower cost.

Q3: What if I am lucky and don’t die? In any case, the premiums would be lost right?

A3: Read the answer to the above question again. That should convince you. Remember, insurance is being bought to protect the financial well being of your family if you die. It is not for your well being. But if it could make you feel any better, what you can do is this – Instead of buying a Rs 5 lac endowment plan for Rs 25,000, you go ahead and buy Rs 1 crore term plan for Rs 10,000. The amount you saved this way is Rs 15,000. Right? Invest this amount every year in equity funds. Chances are high that the total value of your investment after several years (like 20-30 years assuming that is your insurance policy tenure) will be much higher than what your Rs 5 lac endowment plan would give on maturity. And what more, all this while you had a big cover of Rs 1 crore as you bought the term plan. You get the best of both the worlds.

Q4: How much term insurance cover should I take?

A4: It is quite popular to go by thumb rules and take a sum assured of 15-20 times your current annual income. So for example, if your annual income is Rs 10 lac, you can buy a cover of about Rs 1.5 crore. But it’s better to not go by thumb rules alone and instead calculate it correctly. You can refer to this detailed post that I have already written on this topic – How to calculate the right life insurance amount?

Q5: How to decide the Right tenure of the Term Plan?

A5: Under most circumstances, an insurance cover may not be required much beyond retirement. And that is simply because most of your financial goals will be over by then and you would also have accumulated enough money to take care of your dependents (mostly spouse) if you were to die. So if you are 25, then you can take a cover of 35-years which covers you till you turn 60. But if you are 38, then even a 22-year term plan will be sufficient. Shorter the tenure, lower the premium. But if you want to be conservative, you can opt for a slightly longer tenure than what is necessary and just stop paying the premium when the need for insurance is not there. You can refer to this detailed post that I have already written on this topic – How to find the right tenure for the term life insurance policy?

Q6: Term plans are cheap no doubt. But why are online term plans cheaper than offline ones?

A6: When a term plan is purchased online, the costs incurred by the company are less, as there is no middleman between you and the insurance company. This lowering of cost is passed on to you as lower premium as no commission has to be paid to any agent. Most companies offer online versions of their term plans. If you are looking to buy the best online term plan, be sure to do your research and compare across insurance providers and then make the final decision.

Q7: Is the premium of term plans same for everyone?

A7: No. It varies for everyone as it depends on the person’s age, chosen policy tenure, the sum assured, payout method opted for and other premium loadings (if any) due to medical or lifestyle reasons.

Q8: Does the premium of the term plan change during the policy tenure?

A8: No. It remains the same.

Q9: If I die, are there different options in which the sum assured gets paid out to my nominees?

A9: Yes. Insurance companies allow you to chose how the money is paid out to the nominee in case of your death. Suppose you take a term plan of Rs 1 crore. Now if you die, the money can be paid out as any of the following (depending on what you have chosen):

  1. Full Rs 1 crore paid at the time of death
  2. Rs 10 lac paid at the time of death. Remaining 90% (i.e. Rs 90 lac) paid out equally as Rs 50,000 monthly (0.5% of sum assured) for next 15 years
  3. Full Rs 1 crore paid at the time of death. Additionally, Rs 50,000 paid monthly (0.5% of sum assured) for the next 15 years
  4. Full Rs 1 crore paid at the time of death. Additionally, starting with Rs 50,000 monthly (0.5% of sum assured) and increasing by 10% every year paid out for the next 15 years
  5. And there can be many other options depending on what the insurance provider is offering at that time.

Obviously, the premiums charged in each variety would be different. Which one should you chose depends on your need. If your nominees know how to manage a large amount to generate regular income, you can go for simple 1st option. But if you feel they are better of receiving money regularly, then probably you can go for 2nd option (or even the 3rd or 4th option which will have higher premiums). You can even have 2 separate policies with different versions chosen for payout in case of death.

Q10: Should I opt regular premium or single premium?

A10: You can choose either. In regular, you pay premiums every year. In single premium, you premium once and never again. But let’s say you buy a 25-year term plan and die after 5th year. Now if you have taken the regular premium route, then you would only have paid 5 small premiums. But if you had opted for the single premium, then you would have paid in one go and that potentially means that the 20 premiums got paid extra as you died early. Nominee gets the same amount irrespective of what you chose. But I think that’s too small an issue to bother about. You can actually do whatever you feel comfortable with. Some people want to just tackle it upfront (via single premium) and be done with it. Others don’t have a lot of surplus money to do it so prefer regular route. Whatever works for the buyer.

Q11: Does it make sense to buy term plans early or I should wait for some time?

A11: The premium amount increases with age. So earlier you buy, better it is. Also, with passing age, it’s possible that you may unluckily develop some disease that might make it difficult to get a policy later on. So don’t wait too long to buy a term plan later on. Buy it as soon as possible even if it seems too early to do so.

Q12: Does the term plan pay out even if I die in an accident?

A12: Yes.

Q13: Wouldn’t a Rs 10-20 lac term plan cover be enough for me?

A13: No. Don’t be penny-wise pound-foolish. Simply answer this question – If you die today, will your family be able to maintain their lifestyle, pay for children’s higher education, pay off loans and live well for decades to come in just Rs 10-20 lac? The answer will be a big No. So take a plan that takes care of all the above things. You can refer to the earlier mentioned post (about the same question) – How to calculate the right life insurance amount?

Q14: Will Rs 1 crore insurance be sufficient?

A14: Maybe yes. Maybe no. It’s not necessary. Different people will have different optimal insurance coverage requirements. Read this – Is Rs 50 lakh to Rs 1 Crore term insurance enough?

Q15: I want to take a term plan of bigger amount, say Rs 2 crore. Should I split it?

A15: You can do it. But keep it limited to 2-3 policies max. Better limit it to just 2. If you die, your family will have to run around to get all the policies paid out. So think from that perspective.

Q16: What if I am outside India if I die? Will it still pay money to my nominees?

A16: Yes. In most cases. Unless you go and die in a country that is on the unsafe list of the insurance company. So check the list before choosing a country to go and die!

Q17: I want to buy a term plan. But I have a health condition (or family’s health history is odd). Should I hide this information?

A17: Please don’t hide any such information. Death claims can be rejected if the insurance company finds out that you had hidden any critical information. So don’t do it. This may result in slight loading of premiums (increase in premium) that you have to pay. I think that’s much better than having a hanging sword of the possibility of claim rejection in case of death. Be willing to accept the loading of the premiums and move on with it.

Q18: I have few existing insurance policies. Should I disclose them while buying term plans?

A18: Yes. Don’t hide these either. There is nothing bad in having previous insurance policies.

Q19: I have purchased the term insurance. Now what?

A19: Tell your nominees about it. They should be aware of the policy in case you die. Only then they can claim the amount. Isn’t it?

Q20: Anything else?

A20: Stay healthy and try not to die. Your family will get the money if you die. But that’s not an ideal scenario. Isn’t it?

I hope that if you or someone was looking to answer – How to buy the right term life insurance policy? – then they found this article useful.


How much Life Insurance to Buy & How To Calculate the Right Amount?

How Much Insurance To Buy

A reader had a very specific question in Personal Financial Concerns Survey 1.0. It was about calculations related to life insurance amounts.

This is what he had to say:

In past, I have bought insurance policies for saving taxes and investments. But now I understand that these should not be the main reasons for buying insurance. Hence, I want to buy the right insurance cover to secure my family. How much cover is enough for me? People say buying Rs 50 lacs or Rs 1 Crore coverage works. Is it correct?

Now that’s a question that many people have.

I have seen people earning in 7-figures and having insurance cover of 6-figures! 🙂 They believe that a 6-figure amount will be sufficient to take care of their family in case of their death. And these people don’t even have a lot of money saved up.

Tells of risks that people take with their family’s future.

Insurance is bought simply to ensure that insured person’s family does not have to make sacrifices with their standard of living, are able to achieve their future financial goals and close all outstanding loans. That’s it. Nothing more. Nothing less.

But I am not writing this post just to prove that buying life insurance is a must. I am rather concerned about addressing the reader query, which is:

How much Life Insurance to Buy?

It is not that difficult to calculate.

You life cover should be sufficient enough to take care of the following 3 parts:

  • Provide enough money to foreclose all outstanding loans
  • Provide enough money to help meet regular day-to-day expenses of your family for years to come.
  • Provide enough money for your children’s education and marriage.

Lets take them up, one by one…

Part 1: Provide enough money to foreclose all outstanding loans.

This is pretty simple to understand. Just make sure to add any foreclosure charges that have to be paid in case of loan closure.

Lets call this as Amount-Loan-Closures.

Part 2: Provide enough money to help meet regular day-to-day expenses of your family for XX number of years to come.

(Caution – You need to be really sure about what XX is here – as it is the number of years, you think your family needs to be financially supported).

If you think your working spouse will take care of this part on her own, then that’s debatable. Just remember, that in a dual-income family, life style costs and regular expenses generally increase to use a larger part of the combined incomes.

So if suddenly one income stops, it can become a big problem to maintain the existing lifestyle.

Hence, it’s better and safer to make a provision for this as well.

Now how to calculate this amount?

Step 1: Estimate regular annual family expenses (exclude your individual expenses).

Step 2: Subtract the amount you think your spouse can manage on their own (better keep this as minimum)

Step 3: Understand that multiplying the above amount with the number of years (XX above) you wish to support your family won’t work. Why? Inflation. Inflation will increase these expenses every year. So take a safe inflation assumption (say around 8%).

Step 4: Understand that the amount your family gets from insurance company, will be invested and used to generate income. Don’t expect very high rates of returns from the investment. Lower your expectation are, better it is.

Step 5: Use this information to calculate the required insurance amount. This amount will provide enough money for your family to meet regular day-to-day expenses for the XX number of years.

Lets call this as Amount-Family-Expenses.

Part 3: Provide enough money for your children’s education and marriage.

Now it’s a personal choice here – Do you want to provide for your children’s education or marriage needs or not?

Assuming you want to, lets see how to arrive at this figure.

Step 1: Estimate the amount required for your children’s education and marriage, if it were to happen today.

Step 2: Since you children need funds in future, understand that inflation will increase the amount required. So if a MBA from good college costs Rs 15 lacs today, it might cost Rs 35-40 lacs after say 10-12 years. Calculate the amount in future using inflation numbers.

Step 3: You might have already saved some money for these goals. Calculate the future value of these savings and subtract the figure from amount calculated in above step.

Lets call this as Amount-Child-Goals.

 

Now we have calculated 3 figures for each part.

Add these three figures:

= Amount-Loan-Closures + Amount-Family-Expenses + Amount-Child-Goals

This is you current insurance requirement.

But you don’t stop here.

I am sure that you have been careful in your calculations.

But you see, in all calculations above, we had to make certain assumptions. Assumptions that require us to make predictions regarding rate of inflation, rate of return, etc. Now you know that even experts have trouble predicting the future. So at best, our predictions are mere educated guesses and not future realities.

We can always be wrong in our assumptions.

So in order to provide a buffer for mistakes in our assumptions, increase the amount you calculated above by atleast 10%.

Higher you bump it up, better it is.

I personally take it at 25%. (Even if it means that you family ends up with more money than they actually require, it is a good problem to be in. Isn’t it?)

This is the Gross Insurance Requirement for you.

Once you have calculated the figure, you need to subtract a few things from it. You might already have some other insurance policies,  employer-provided insurance covers, existing savings and investments earmarked for some of these child_goals . Subtract these amounts from above figure.

This will give you the additional insurance cover you need to purchase.

You can use the following grid as a guide:

Life Insurance Calculations

I am sure that once you are done with your calculations, a huge amount will be staring at you from your calculation sheet. Many of you who have endowment plans, moneyback plans, etc. as insurance covers, will even fear asking about the premiums for such large covers.

But don’t worry. Solution is there. And it is to buy plain term insurance cover. Its cheap and can provide coverage of almost Rs 1 crore for around Rs 10,000 – Rs 12,000. But remember one thing – term insurance has no survival benefits. You won’t get any money in case you don’t die within the insured period.

 

Important points:

  • Buying a term insurance does not mean that you don’t need to save for your future goals(retirement, kids education). It is only a backup plan in case you don’t survive that long. Insurance is not investment.
  • You are smart enough to purchase the right insurance cover for your family. But are your family members smart enough to deploy the huge insurance amount correctly (which they get when you die)? Don’t bet on it. Make sure that you sit with them and educate them what insurance is. And more importantly, what to do when they get the big amount. Tell them where to put the money and when to withdraw it. One wrong decision on their part and they will lose the money (a part or whole, who knows). And worst is that this is inspite of you having taken care of everything. So make sure you educate them.

There is a way to reduce your insurance requirements. Suppose you want to provide for your family’s expenses for 25 years (Part 2 of the above discussion). But your child’s education goal is just 10 years away (Part 3). So if you follow the approach discussed in article above, it will mean that you are paying for providing risk cover for the child’s education goal, even after its completion (i.e. 25 – 10 years = 15 years).

Effectively, you might find yourself paying a premium for sum assured that is higher than what is actually required. But that is not completely wrong. As I said, being over-insured is any day better than being under-insured. In any case, your insurance requirements keep changing every year.

The problem (though wrong to call it that), is solvable through an approach known as laddering of insurances. Its an approach where one buys term insurance plans of different durations that correspond to major goals like kids education, marriage, etc. Once the period of shorter-term plan is over, it frees up cash that can be invested elsewhere. Its an interesting topic – Laddering. I will write about it in another post soon.


4 Common Mistakes to Avoid while Buying Your Term Insurance Plan

I have always been of the view that it’s wiser to keep investments separate from insurance. And that means sticking only to plain-vanilla term insurance plans instead of moneyback endowment policies.

Buying term insurance is very important to fulfil your and your family’s protection needs. Such a plan provides coverage for a specified period, thus giving you financial security and proving to be extremely useful in cases of emergency. But even when you have decided to buy a term plan, it is essential to choose the correct insurance plan for them. Some of the most common mistakes that people make and you should avoid are:

1 – Selecting the cheapest policy

Several potential policyholders think that the cheapest policy will save their money while giving them the required financial security. They browse through a lot of policies and choose the one that carries minimum charges.

Opting for the cheapest term insurance plan is not always the smartest idea. It is important to know that when you select such a policy, you might lose out on some vital features. Factors like flexibility, length of guarantee period, convertibility rights, available riders and the company’s financial standing are crucial points of consideration when selecting a policy.

Choose a policy with more worth than one with lower cost alone. You can easily compare term insurance policies over the Internet. You will soon realize that by paying just a little more, you may get a range of useful features.

2 – Failing to get proper coverage

Review your family’s needs taking into consideration the age, lifestyle and requirements of each member. Also review your annual income including tax payments. These should give you a fair idea of how much term insurance cover you need.

3 – Ignoring the tenure

Determining the period for which you require the coverage is very important. The term of the plan should be sufficient enough for your needs. Choose the tenure according to your age. For instance, if you are in your 20s then you might require a longer tenure than someone who is in his 60s.

4 – Taking a break between policies

Many policyholders realise they made a mistake after choosing a policy. In such a situation, they drop the current policy and later opt for a new plan or a new insurance provider. This could prove dangerous – what if they encountered an emergency in between policies Always choose a new term plan first and then drop the earlier one. This will ensure that you don’t lose coverage at any time.

If you make any of these mistakes while choosing a term insurance, your plan would prove futile to give you protection and may rather act as a financial burden to you. To avoid facing such problems, stay wary of these common mistakes. Choose the perfect term insurance plan and protect your family well.



292 Words to Change Your Financial Life…Today!!

This post is inspired by Rohit’s brilliant poston how to manage your money. I am borrowing few of his ideas & adding a few myself.

  • Never depend on just one source of income.
  • Save atleast 20% of what you earn from all sources.
  • Buy a plain Term Life Insurance of Sum Assured amount equal to atleast 30 times your annual expenses.
  • Buy a health insurance for yourself and those who depend on you.
  • Create an Emergency Fund equal to 6 months worth of your expenses. Till the time you have not created such a fund, don’t think about investing or buying luxury items.
  • Start Monthly Recurring Deposits of 6 months. At the end of 6 months, use the maturity amount to create a FD for 1 year. Repeat every 6 months. To start with, use 20% of your savings (in step 2) to start Recurring Deposits.
  • Use the remaining 50% of your monthly savings to invest in Stock Markets via SIP in Index Funds or well-established, diversified mutual funds. Do not go for sector specific funds.
  • Use remaining 30% of your monthly funds to create a Market Crash Fund (use another RD). Keep saving money in it till the market crashes. When it does, buy quality stocks at low prices. To know which are quality stocks worth buying in market crashes…

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  • Gold, silver and precious stones are good for social or religious requirements. These are not investments. These are insurances against bad times. (To understand this point, just think for a moment that will you sell gold or silver in case prices go up? The answer would be a No. You sell these only when everything else is lost. Period.)
  • And always remember :

          Investment & Insurance are different things.
          Investment & Savings are different things
          Do not consider Insurance as Investment or Saving.

Above might work for most of us and does not require any complex rocket science to be implemented.

So go on….say good bye to your brokers and financial advisors. 🙂

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