How much life insurance do I need?

One cannot pinpoint the ideal amount of life insurance to buy exactly. But one can make a sound estimate by considering financial situation and by imagining what your loved ones will need in the coming years.

In general, you should find the ideal life insurance policy amount by calculating long term financial obligations and then subtracting the assets. The remainder is the gap that life insurance will have to fill. But it can be difficult to know what to include in your calculations, so there are widely calculated thumb rules meant to help you decide the right coverage amount.

Here is a rule of thumb meant to help you decide the right coverage amount:-

Debt, income, mortgage and education

This encourages you to take a detailed look at debt, income, mortgage and education, the four areas that you should consider when calculating your life insurance needs.

Debt & Final Expenses – Add up your debts, other than your mortgage, plus an estimate of your funeral expenses

Income – You need to decide for how many years your family would need support and multiply your income by that number. The multiplier might be number of years before your youngest child graduates from high school.

Mortgage – Calculate the amount you need to pay off your home loan.

Education – Estimate the cost of sending your kids to college.

How to find your insurance coverage number?

Follow this general philosophy to find your own target insurance coverage amount:

Financial obligations minus liquid assets

Calculate obligations: Add your annual salary (times the number of years that you want to replace income) + your mortgage balance+ your other debts + future needs such as college and funeral costs.

From that, subtract the liquid assets such as: savings + existing college funds+ current life insurance

Here is a situation and the goal:-

Rajeev has a life insurance cover of only Rs.20 lakhs. Rajeev would like to insure the living expenses for the future 30 years for his family. He wants that his family should receive 90% of present household expense inflation adjusted every month. Rajeev’s monthly household expense is Rs.40,000 per month. The investment will be made in debt fund @7%. The inflation rate is 5.5%.

The total insurance corpus requirement will be Rs.1,05,71,384. After excluding the existing insurance of Rs.20 lakhs the estimated net insurance corpus required is Rs.85,71,385.

Tips to keep in mind

• Rather than planning life insurance in isolation, consider the purchase as part of an overall financial plan.

• The plan should consider future expenses such as college costs, future growth of your income and assets. Once this information is known, then you can map the life insurance need on top of the financial plan.

• Remember your income likely will rise over the years, and so will your expenses. While you cannot anticipate exactly how much either of this will increase, keep a cushion that makes sure that your spouse and kids can maintain their lifestyle.

• Talk your numbers through with your spouse. How much does your spouse think the family would need to carry on without you?

• Consider buying multiple, smaller life insurance policies. For instance you could buy a 30 year term policy to cover your spouse until your retirement and a 20 year term policy to cover your children until they graduate from college.