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Friday 14 November 2014

How to know how much life insurance do you need

Best form of insurance is term insurance and best savings is long-term investment in equity through mutual funds

Adequate life Insurance cover, a good saving habit and an early started retirement planning are three basic elements of a healthy service life. Experts say, best form of insurance is term insurance, best savings is long-term investment in equity through mutual fund and best retirement planning is long term asset accumulation through diversified investment.

But, the most common incident seen among the middle class people is that in early part of their service life they are irregular with their saving habit. Being unable to differentiate among the asset classes, they often end-up a good part of their working life by aimless savings and futile investments. Nevertheless, it is better late than never. In this article, an attempt is made to discuss some aspects of life insurance and retirement planning:-

How much life insurance cover is sufficient?

Life Insurance is needed to give financial protection to the dependent family in case of unfortunate death of the breadwinner. Unlike general-insurance (where the value of the asset to be insured is ascertained at first); life insurance can’t assign a value to a human life; but it targets to compensate for the financial loss to the family in absence of the breadwinner.

So, to assess the adequacy of life insurance one has to know how much financial loss his family will suffer in his absence.

Here, the Human Life Value Approach (HLV) is known as the most comprehensive approach, which involves calculating the lifetime income of the individual (making adjustments for all expected hikes and cuts) and discounting it at appropriate rate to arrive at the present value of all future earning of the individual.

Since this approach is a bit technical, one can also use a simple and handy arithmetic calculation to check whether his life insurance cover is sufficient or not :-
70% of annual income + other liabilities and outstanding loans

Current Annuity Rate

The resultant figure of the above formula is presumed to be sufficient to support the family in case of unfortunate death of the breadwinner. Here, 70% of one’s annual income is taken because other 30% is supposed to be one’s self maintenance cost (however, the figure is presumptive and subject to change from individual to individual). Currently the annuity rate offered by premier life insurance companies is around 8 %. Since, this rate is subject to change and one need to re-check the sufficiency of life insurance periodically.

In addition to annuity rate, a change in one’s liability composition can also change his life insurance need. Pure term insurance is the best and cheapest choice for this purpose. But, the Problem with most of the people is that they think term insurance is wastage, because it has no maturity value. These people prefer endowment policies and use these policies as saving instruments also. Be aware that the fundamental purpose of all life insurance policies is to give a potential life cover to the life assured and other features are mere attachments.

Still, some additional advantages available with the endowment policy often allure people. The advantages may be: - these policies generate some forced saving, these policies are acceptable as collateral deposits, additional premiums give income tax advantages, and maturity benefits are tax-free and so forth. In any case, please note that as saving instruments life insurance policies mayn’t always beat inflation. Still, if you are not a good investor and happy with a fair return on your money, you may check some high cover endowment type plans for a longer term or opt for some premium back term plans also.

Please, take care of three important aspects while purchasing your life insurance:-

i) While purchasing any endowment type policy choose a term, which may give maturity just before your retirement. Endowment policies taken at younger age for longer term often give a better return.

ii) Surrendering any insurance policy in middle of the term is not at all advisable. You will lose your life cover and a part of your accrued bonus also. Therefore, always take a term (the maximum possible) which will best fit your purpose.

iii) Check the claim settlement record and if possible the profit and loss position of the company from which you purchase your policy.

Again, a term insurance policy along with a PPF account is a widely preferred combination for insurance plus savings purpose.

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