One of the most frequently asked financial question is this – How much life insurance is enough? Let’s understand this once and for all. Your life insurance, whether it is enough or not, depends on various factors. These include – the stage of your life and career you are in, your life goals, your financial obligations, size and nature of your family, etc.
There are various approaches through which you can find out whether your life insurance is enough or not, but in the context of India and the usual pattern of life insurance needs that we have and I am usually asked about, my suggestion would be to follow the ‘family needs approach’.
As the name suggests, the family needs approach to insurance planning is all about identifying how much insurance would you need in order for your family to meet its various financial aspirations and obligations in the event of your death.
Family Needs Approach:
Step1: Divide your family’s financial requirements into three categories:
- Immediate Needs on your death – It might include cash requirements for immediate payments such as taxes, settlement costs, loan EMIs, credit card bills, education expense for children as well as money for sudden emergencies.
- Continuing Needs – These include ongoing expenses such as food, shelter, clothing, transportation, etc. The amounts will definitely vary from person to person on case to case basis and also depend on whether there are any more earning members in your family or not.
- Special Needs: This refer to special funding needs such as college funding, succession planning, etc.
Step 2: From the total amount needed for your family’s financial needs, subtract the total assets that your family could use. The difference (if any) is the amount you need as life insurance proceeds.
Let say you and your wife are trying to calculate how much life insurance you need. Your Family Approach Method gives you the following details (Amounts are given just as an example):
- Medical Expenses – 5000
- Property Settlement Cost – 20,000
- Loan and Credit Cards – 40,000
- Emergency Fund – 10,000
Subtotal – Rs.75,000
- Providing for children’s needs for a period of time – 6,00,000
- Providing for wife’s needs till her retirement – 4,00,000
Subtotal – Rs. 10,00,000
So adding the subtotals, you and your wife come to the conclusion that in the event of your death your family would require Rs. 10,75,000.
Now you should identify the assets available to offset your family needs. Let’s say you have:
- Savings – Rs. 80,000
- Investment – Rs. 2,00,000
- Retirement Assets – Rs. 3,00,000
- Existing Life Insurance – Rs. 2,00,000
Subtotal – Rs. 7,80,000
Thus, the difference between your family needs (Rs. 10,75,000) and your available assets (Rs. 7,80,000), that is Rs. 2,95,000 is essentially your life insurance need.