Purchasing a life insurance policy is an important life decision to fulfill our family’s collective life goals, making it an essential long-term instrument, which can help families in minimising the impact of unexpected financial vulnerabilities. While it is not possible to specify the amount of life insurance required, it should be more than adequate to ensure settlement of your existing financial liabilities, fulfillment of your family’s future requirements and continuity of investments towards your life goals.
Calculating your life insurance cover becomes far less tricky if you are clear about your financial situation and the potential risks to your dependent’s financial well-being. A lot of variables go into calculating how much life insurance is needed, how long it is needed, and what is an appropriate amount to actually insure. Often, financial experts will recommend some multiple, generally 10–12X of your annual income—it is an oversimplification, which overlooks several elements like inflation, your debt obligations and your life goals such as providing for your child’s higher education or paying off your home loan. As a thumb rule, put a higher emphasis on why you need life insurance, rather than the coverage amount to keep your bases covered. It is essential that you keep the following factors in mind while choosing the face value of your insurance policy:
Life Goals:
Many of us are actively investing towards the fulfillment of dreams and aspirations for our loved ones. These life goals may include plans to send your kid to the finest university abroad, buying a home for your family or a financially secure retirement for your partner. Sudden loss of your income might jeopardise the continuity of investments towards such goals. Therefore, it is necessary to prioritise your life goals and provide security against them by including the required amount of your goals, in your life insurance cover.
Income Replacement:
Another key purpose of life insurance is income replacement. If you are the only provider for your dependents, you will need a policy payout that is large enough to replace your income and take care of your family’s life goals while providing a guard against inflation. Determine for how many years your family would need financial support, and multiply your annual income by that number. The multiplier might be the number of years before your youngest child graduates from college. To be on the safe side, add one time of your current annual income back into the amount determined above - this is a fairly good guard against inflation.
Debt Obligations:
In your absence, all of your liabilities, which may include car loans, mortgage, credit cards and personal loans, must be paid off in full. Hence, it is essential to purchase sufficient sum assured so that your beneficiaries can continue to achieve their life goals without having any financial burden to pay off loans, especially if they were secured by collateral that your dependents need to continue using, like your home.
Apart from these, you should also account for health contingencies and increasing costs of healthcare and medical treatment in your policy amount. Opt for a health insurance plan, ensuring that your savings are not depleted for any medical emergency, but are used for achieving the pre-determined life goals. Other than policy amount, be careful from whom you buy your policy from, research, compare and analyse your policy benefits and rates online. You should go for the insurer who provides you with optimum benefits and has a good claim settlements record.
Careful planning helps you prevent the pitfalls of under-insurance. Buying a little more coverage than required is advisable as your income is likely to increase over the years, and so will your expenses. While you cannot anticipate exactly how much either of these will increase, a cushion helps make sure your dependents can maintain their lifestyle and fulfil their goals.
The author is the Chief Distribution Officer - Retail, Bajaj Allianz Life insurance