Life insurance is a contract between the insurance company and the insurer, where the insurer agrees to pay a certain sum of money every month or year or quarter (as per the contract terms), and the company in turn pays the insurer's family a lump sum amount of money on the event of the insured individual's death or in case of critical illness.
Death is the inevitable truth of every individual's life. If your are the breadwinner of your family, and (god forbid) you embrace the bitter truth of life, i.e. death, anytime sooner than later. Phew… The thought itself horrifies you, doesn't it? Your family is no doubt going to miss you. But along with the physical loss, will accompany the financial loss. To keep going and live life as per the same standards as before, will not be easy for your family. To pay off your present debts if any, children's education costs, maintaining the present standard of living, inflation costs, and so on, will have to be taken care of, after you are gone. Life insurance helps restore all this. All your family has to deal with is your physical loss which no one in this world can replace. Everything else will be taken care of, if you have a proper
life insurance. Now, if you are an individual with no dependents, you might be able to do away with life insurance, but if others depend on your income, life insurance is a good idea to replace your earning potential, when you are gone.
How Much Life Insurance Does a Person Need?
How much life insurance do you need is very subjective and not easy to answer. It's not some magic number that is derived. A lot of calculations and factors are to be considered while determining how much life insurance do you really need. Listed below are a few factors to be considered while actually calculating how much life insurance is enough for you.
Factors to be Considered - Your present financial standing.
- Whether or not your spouse is working.
- Any major expenditure in the near future like buying a new car, an apartment, children's education fees, and so on.
- Debt to be paid off (if any).
- Present size of savings of the family.
- Social benefits, pension benefits, etc., available after death.
How Much Life Insurance is Enough?
- Your main goal is to replace your present income, so as to maintain the same lifestyle.
- Consider your financial situation and ponder upon the factors above.
- List down the factors to be considered, and also about some big expenditure, if any to be made in the near future.
- Once you're done with the above working and sure of your short term and long term needs, you will come to a certain figure, you would want to replace it, say yearly. Let's call it A.
- To A now add all family maintenance expenses like entertainment, utility bills, travel and transportation, etc., on a yearly basis.
- This figure is going to be something close to your annual salary or slightly more than that, since you consider a lot of other costs as well. Let's call it B.
- To this figure you ought to add the inflation cost which rises at a pace of around 2% every year. We get C.
- Now, count all your liquid assets like stocks, bonds, savings, and if you have other assets elsewhere, which can be liquidated. We will call it D.
- Then reduce all the liquid assets from the figure you have calculated. i.e. (C - D).
- The figure you arrive at is exactly what you are worth, and has to be replaced.
- This figure represents the amount of life insurance you must buy.
To make things simpler, I have a simple formula you could use:
Long-term needs + short-term needs + inflation cost – resources (that can be liquidated) = how much life insurance you should have. |
It is easy to get a large cover of life insurance, but in reality, you end paying a lot of extra money, and hence, blocking your capital. So, it's important you get just enough insurance cover so as to assure the replacement of your present income. You can also consider a financial planner, who should be able to help you out with exact the amount of life insurance required.
Life insurance comes in different sizes and boasts of different features, prices and terms. If you need a life insurance, make sure you educate yourself to make the right choice, because you don't want to end up paying more or stuck with inadequate coverage. Choose a policy that is more likely to fulfill all your financial hopes. Last but not the least,
please read the offer document carefully before investing!