THE WHY AND HOW OF LIFE INSURANCE
We have tried to answer these questions like
. Why do you need life insurance?
. How to design your life insurance corpus?
. How to account for your current financial assets and expected outflows in future?
. What are the critical factors to keep in mind?
If you are not sure if you at all need a life insurance, then you are not the only one.
So here is a rationale to decide if you need a life insurance or not.
Insurance is a function of your financial liability. If you have adequate assets to
take care of your liabilities, then you don’t need to spend on life insurance. Now,
the question here is how do you determine your financial liabilities? Well, you need
to take a stock of what kind of financial goals & financial responsibilities your family
will have, in your absence. The areas like children education & marriage, 1st or 2nd
Home etc. are easy to estimate. The difficult part may be in arriving at a value for
income replacement. This is simply a sum total of all money that your spouse will
need for monthly household expenses between today and end of his or her life,
adjusted for inflation and expected return, net of tax. We normally recommend a
life expectancy of 85 years. You can use present value formulas in excel for such
calculations or ask your Financial Planner.
Now, you know how much money your family will need if you are not around
today. So let’s look at how much money your family will get if anything happens to
your family today. So total up the sum assured in your insurance policies and also
see if your Employer has any life cover for you. Don’t forget to also calculate the
value of net assets that you hold today. Now, while you do that, remember to
exclude the consumption assets like your house where you stay and the Gold &
Jewellery that your family uses. From this, subtract, outstanding liabilities so you
have net assets figure. Ensure you include current values of your retirement
accounts. A critical assumption here is that your financial assets will be liquidated
by the family as and when needed to meet the financial goals.
So, now, you should know how much your spouse will ‘need’ and how much your
spouse will ‘have’. We are sure this is complicated for you, so let’s try to give you
an example.
Suraj and his Wife Chanda have an 8-year Son, Joy. So here is how Suraj
calculated his Life insurance corpus need:
Education Corpus for Joy Rs. 13 Lakhs
Marriage Corpus for Joy Rs. 5 Lakhs
Income Replacement Rs. 82 Lakhs
Total Needed [A] Rs. 100 Lakhs
Sum Assured total of all Insurance Policies Rs. 25 Lakhs
Value of Financial Assets Rs. 42 Lakhs
Current Liabilities Rs. 7 Lakhs
Net Financial Assets Rs. 35 Lakhs
Total Available [B] Rs. 60 Lakhs
Insurance Corpus Gap [A-B] Rs. 40 Lakhs
Suraj can buy an online term plan for Rs. 40 Lakhs to bridge the current gap in his
Insurance Corpus. Kindly note that this is a simplified illustration and you may have
other factors to be considered. There are alternate methods to calculate your life
insurance need. As an example, say 10 times your current annual income or
corpus taking your future income in account.
Key factors to keep in mind:
1. Don’t forget to include the investments that you may have made (e.g. ULIP
Policy)
2. Consider your spouse’s profile as the money will have to be managed by her /
him as you will not be around
3. Involve your spouse as you work on your insurance corpus
4. Balance between the need to cover the financial risk v/s. the cost of insurance
5. If your insurance corpus works out very high, then revisit the outflow in each of
the goal and see if you can optimize. See if your spouse can partly work & see
if a higher ROI can be assumed in the insurance corpus.
6. It may help to take a psychometric test to know risk tolerance for your spouse
and yourself
7. Take a tenor that goes up to around your retirement age. As your financial
liabilities will be fulfilled and financial assets will grow, the need of insurance will
go down drastically.
We have tried to answer these questions like
. Why do you need life insurance?
. How to design your life insurance corpus?
. How to account for your current financial assets and expected outflows in future?
. What are the critical factors to keep in mind?
If you are not sure if you at all need a life insurance, then you are not the only one.
So here is a rationale to decide if you need a life insurance or not.
Insurance is a function of your financial liability. If you have adequate assets to
take care of your liabilities, then you don’t need to spend on life insurance. Now,
the question here is how do you determine your financial liabilities? Well, you need
to take a stock of what kind of financial goals & financial responsibilities your family
will have, in your absence. The areas like children education & marriage, 1st or 2nd
Home etc. are easy to estimate. The difficult part may be in arriving at a value for
income replacement. This is simply a sum total of all money that your spouse will
need for monthly household expenses between today and end of his or her life,
adjusted for inflation and expected return, net of tax. We normally recommend a
life expectancy of 85 years. You can use present value formulas in excel for such
calculations or ask your Financial Planner.
Now, you know how much money your family will need if you are not around
today. So let’s look at how much money your family will get if anything happens to
your family today. So total up the sum assured in your insurance policies and also
see if your Employer has any life cover for you. Don’t forget to also calculate the
value of net assets that you hold today. Now, while you do that, remember to
exclude the consumption assets like your house where you stay and the Gold &
Jewellery that your family uses. From this, subtract, outstanding liabilities so you
have net assets figure. Ensure you include current values of your retirement
accounts. A critical assumption here is that your financial assets will be liquidated
by the family as and when needed to meet the financial goals.
So, now, you should know how much your spouse will ‘need’ and how much your
spouse will ‘have’. We are sure this is complicated for you, so let’s try to give you
an example.
Suraj and his Wife Chanda have an 8-year Son, Joy. So here is how Suraj
calculated his Life insurance corpus need:
Education Corpus for Joy Rs. 13 Lakhs
Marriage Corpus for Joy Rs. 5 Lakhs
Income Replacement Rs. 82 Lakhs
Total Needed [A] Rs. 100 Lakhs
Sum Assured total of all Insurance Policies Rs. 25 Lakhs
Value of Financial Assets Rs. 42 Lakhs
Current Liabilities Rs. 7 Lakhs
Net Financial Assets Rs. 35 Lakhs
Total Available [B] Rs. 60 Lakhs
Insurance Corpus Gap [A-B] Rs. 40 Lakhs
Suraj can buy an online term plan for Rs. 40 Lakhs to bridge the current gap in his
Insurance Corpus. Kindly note that this is a simplified illustration and you may have
other factors to be considered. There are alternate methods to calculate your life
insurance need. As an example, say 10 times your current annual income or
corpus taking your future income in account.
Key factors to keep in mind:
1. Don’t forget to include the investments that you may have made (e.g. ULIP
Policy)
2. Consider your spouse’s profile as the money will have to be managed by her /
him as you will not be around
3. Involve your spouse as you work on your insurance corpus
4. Balance between the need to cover the financial risk v/s. the cost of insurance
5. If your insurance corpus works out very high, then revisit the outflow in each of
the goal and see if you can optimize. See if your spouse can partly work & see
if a higher ROI can be assumed in the insurance corpus.
6. It may help to take a psychometric test to know risk tolerance for your spouse
and yourself
7. Take a tenor that goes up to around your retirement age. As your financial
liabilities will be fulfilled and financial assets will grow, the need of insurance will
go down drastically.
Happy Investing
Source:Gettingyourich.com
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