Life is uncertain. That’s why life insurance was created as a financial instrument that provides a safety net for your family in case of your untimely death. Getting yourself insured for a certain amount means your family will have access to that much money if you are no longer there to take care of your responsibilities.
Do you need life insurance? If you have no dependents and there are no pending financial obligations such as home loan or auto loan, you are a free bird with no need for any life insurance cover. It is quite unlikely that you have zero obligations. You need the safety of life insurance if you have dependents to take care of and/or if you have financial liabilities.
Why to buy life insurance?
- To ensure financial safety of your family in the event of your demise
- To fulfil your financial obligations in the event of your demise
Given the purpose of life insurance, anyone with a family to support and a breadwinner of the family needs life insurance to cover the risk of untimely death. Even housewives need life insurance.
How much life insurance cover is needed?
The amount of life insurance cover depends on your family responsibilities, future financial liabilities such as home loans, car loans, education of children, ensuring regular income for dependents for their life term.
Let us assume that you, aged 35 years, are the sole breadwinner of your family and have two young kids, dependent parents and, of course, your spouse, aged 30 years. Currently, your household expense is Rs 25,000 per month. There’s a home loan with pending principal amount of Rs 30 lakh, and a car loan of Rs 4 lakh. Your existing financial liabilities are at Rs 34 lakh.
To arrive at the correct insurance cover amount, we assume the scenario when you are no longer there to support your family. You will have to ensure that your family has access to a regular monthly income of Rs 25,000 per month, for at least the remaining period of your spouse’s life expectancy. Let’s assume life expectancy to be 75 years. So, your spouse has 45 years to live.
You need a fixed deposit corpus that generates monthly interest income of Rs 25,000 per month. At 8% annual return, you need Rs 37.5 lakh in fixed deposit to generate the desired monthly income. Had there been no inflation, you needed an insurance cover more than Rs 71.5 lakh (Rs 37.5 lakh + Rs 34 lakh) so that your family can repay your debts and get Rs 25,000 per month for years to come.
However, inflation must also be taken into account when arriving at the exact amount of life insurance cover required. So, your family’s monthly expenditure will increase over time due to the impact of inflation on cost of living. Assuming inflation rate of 8%, your family’s monthly expenditure would have surged from Rs 25,000 to a whopping Rs 7,98,011 in 45 years. (Calculated as the total amount using the compound interest formula to the monthly expense as the principal amount, the rate of interest as inflation rate and the tenure as remaining life of your spouse.)
To negate the decline in purchasing power of rupee due to inflation, we need to increase the fixed deposit amount so that the monthly expenditure can be met even at the end of your spouse’s life expectancy. If the inflation is assumed at 10%, you will require your corpus in fixed income deposit at Rs 2,20,27,590.
After factoring in the life expectancy and inflation, your total insurance cover required is approximately Rs 2.55 crore.