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Before the question "how much life insurance cover one should buy", the first question is to determine "whether you need life insurance". If you have no dependents and/or have adequate assets to cover your debts and assist your dependents if you are not around, then you don’t need life insurance. However, if you have dependents but do not have sufficient assets to provide for them or the assets are not sufficient to cater to the debts in your absence, then you certainly need life insurance.
Life insurance requirement can be evaluated using few basic steps:
How much debt you have? All of your debts must be paid out in full if something happens to you. So, for example, if you have a total debt of Rs 50 lakh, including all loans, then you need a life cover of at least Rs 50 lakh to cover all your debts. However, you also need to consider that your debt is not increasing each month.
How much income do your dependents need in case of unfortunate death? One of the biggest factors for buying life insurance is for income replacement, which forms the major determinant of the amount of the life cover you need on your policy.
Let’s assume you are the only earner in your family and you bring home Rs 10 lakh a year after tax. If you are not around, the expense that are incurred on yourself shall not be required and hence you may assume as a thumb rule that the yearly income required for your dependents as income replacement is 80 per cent of Rs 10 lakh i.e. Rs 8 lakh. You need enough life insurance such that after investing the proceeds from the life insurance policy, it gives your dependents an annual income of at least Rs. 8 lakh. To convert this into lump sum, which would be the life insurance proceeds, it would depend on how long your dependents require the income. In this example, Rs 1 crore as the life insurance proceeds should suffice for 15 years and Rs 1.5 crore for 25 years, assuming a real rate of return of 2.5 per cent per annum in the long term i.e. after allowing for inflation. To choose for many years you need to replace your income, you need to consider at what age will your existing investments and savings would become enough to self-insure. For this purpose, you may simply assume age as 60 years which would be your typical retirement age. You may also choose a financial advisor to figure out.
Insuring others? Similarly, if you are partially dependent on your spouse who is also earning, follow the same income replacement principle to assess how much life insurance cover you will need to insure your spouse.
Any future needs? If you want to insure the future needs such as your child’s future education or any other essential planned expenditure in future, you will have to estimate the costs of these and add to the insurance cover you need.
You may offset the above determined life insurance cover with the other life insurance covers that you may already have, for example, the life insurance cover offered by your employer or the life insurance cover in your other insurance policies.
It is advisable that you periodically review your life insurance coverage to determine whether you have sufficient life insurance cover, especially on occurrence of a life stage event such as your child’s birth, buying property against loan, etc. There are a range of life insurance plans in the market offering flexibilities in the form of lump sum proceeds or regular income to choose from.
The author is chief appointed actuary at Bharti AXA Life Insurance
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