Life Insurance Planning- How much insurance you required under need-based method?
Life Insurance Planning is very important in Insurance Planning. There two methods that you can plan to take Life Insurance Policy. 1. Human Life Value or Income Replacement Method. 2. Need-based method. The life insurance coverage required you can calculate with any one of the methods.
In the first place, you should know that life insurance and insurance should not be mixed(read this), and also term insurance is the only policy which is good to take in life insurance to protect dependants from financial loss.
Soon I will write an article about the term life Insurance and its benefits.
In addition, It is always advisable that only earning member should take life insurance.
What is Need-based method in Life Insurance planning?
Earning members in the family will be having some financial goals and commitments life child higher education, child marriage, dependant expenses loan clearance and house etc.
In addition, if the earning members in the family suddenly die then all their financial goals(commitments will go for a toss).
Of course, to conquer such risk, Life Insurance Planning is a must for the earning members of the family.
Moreover, This planning method will help earning members of the family to achieve their financial goals even when they die.
Unlike the Human Life Value method, this method tells you to take insurance only when there is a need to take the policy.
Human Life Value method of calculation tells you the wealth your family is going to miss in case of your death.
Hence, sometimes you may end up taking too much insurance under Human life Value, even if you do not need.
Planners life us do not recommend Human Life Value because, with limited income sources, you have to achieve your financial goals.
Therefore, you have to use your income wisely to achieve financial goals.
We do not know when we are going to die. As death is certain but when we will die is uncertain.
If there is no need for Life Insurance, that means no need to pay any premium for life insurance and the same amount can be invested for other financial goals.
The Steps involved in this kind of Life Insurance Planning…
Life Insurance required under Need-based method steps involved are…
- Analyze the present value of the total loan balance that you have to pay including home loan, personal loan, business loan and vehicle loan etc.
- Find out the amount needed to leave today in case of your death for special needs like child higher education, house etc.
- Calculate the corpus needed to be left today for dependant expenses( spouse or parents or both).
- Sum all the above values, and this is the life insurance required for you. But you need to deduct discretionary assets value from this value.
- Calculate the discretionary assets total value like physical assets like lands, buildings gold etc(excluding own house) and Financial assets Bank Fixed deposits, stocks, mutual fund investment and other deposits
- Then deduct your discretionary assets total value from the insurance required value arrive in point number (4)
- Then calculate insurance required to be taken by wife and husband if both are working. They can take life insurance depending on the ratio of their income for the family. ( if their income is equal then they have to take equal life insurance as they are earning 50%:50% of total family income).
- Imp note… You need to deduct existing term life insurance from the value arrived in the above step.
Let’s do the calculation of required life insurance under this method with an example…
Mr. Ravi(age 32) earning 6 lakh per annum and his wife Suchita(age 30) earning 3 lakh per annum.
This family has 5 lakh car loan and 2 lakh personal loan, and this own 1 plot at Bangalore which costs 30 lakh and 20 lakh mutual fund investment.
This family has the following financial goals…
- They want to buy a house after 5 years, and the cost of such house in today’s cost is 35 lakh and inflation expected is 7%, risk-free return expected is 6%.
- They have a boy child(present age 1 year), and they want to plan for the child higher education at age 18. Inflation expected for this goal is 10% and risk-free return expected is 6%.
- This family present monthly household expenses are Rs.30,000, and they want to cover these expenses if any one of them or both die for 50 years from now, and the Inflation expected for this goal is 7% and risk-free return expected is 6%.
Let’s calculate each goal present value to do Life Insurance planning for this couple…
Step 1) Total present value loans outstanding = 7,00,000( 5 lakh car loan + 2 lakh personal loan).
Step 2) Special needs…
| Present Value of the House | |||||||
| in today’s cost | 35,00,000 | ||||||
| No. of years left for the house to buy | 5 | ||||||
| Inflation expected for house goal is | 7% | ||||||
| So, the future value of the house after | |||||||
| 5 years ( using formulae Fv=pv*(1+r)^n) | ₹ 49,08,931.06 | ( using formulae Fv=pv*(1+r)^n) | |||||
| But 49 lakh is not required today, anyone | |||||||
| or both of them died today. | |||||||
| As they can invest in this 49 lakh | |||||||
| in the risk-free asset class to get 6% | |||||||
| risk-free return. So, We should | |||||||
| calculate discounted value | |||||||
| of 49 lakh with 6% discount rate | |||||||
| for 5 years. | |||||||
| So, the Present corpus needed to | |||||||
| be left for house goal in case of death is (using pv=fv/(1+r)^n) | 3668238.853 | (using pv=fv/(1+r)^n) | |||||
Child Higher Education Goal…
| The present value of the | 20,00,000 | ||||||
| child Higher Higher Education | |||||||
| No. of years left for the higher education | 17 | ||||||
| Inflation Expected for this goal is | 10% | ||||||
| So, the Future Value of the Higher | |||||||
| education goal is ( Using Formulae Fv= pv*(1+r)^n | 10108940.57 | ( Using Formulae Fv= pv*(1+r)^n | |||||
| But 1 core is not required today, anyone | |||||||
| or both of them died today. | |||||||
| As they can invest in this 1 crore | |||||||
| in the risk-free asset class to get 6% | |||||||
| risk-free return. So, We should | |||||||
| calculate discounted value | |||||||
| of 1 crore with 6% discount rate | |||||||
| for 17 years. | |||||||
| So, the present corpus needed to be left | |||||||
| for child higher education in case of death | |||||||
| of any one or both is using pv= fv/(1+r)^n | 3754100.837 | ||||||
If you add these two special needs values
( house and child higher education), then the life
insurance required for special needs is
| 7422339.69(life insurance required under special needs) |
Life Insurance required for household expenses replacement is…
| Present House Hold Expenses | 30000 | |
|---|---|---|
| No. of months these expenses should be insured | 600 | |
| Inflation Expected | 7% | |
| Risk Free Return | 6% | |
| Rear Rate of return | -0.009345794 | ( real rate = (1+r)/(1+inflation)-1) |
| Monthly real rate of return | -0.000782172 | |
| So, the present corpus needed to be left if any one or both die is | ₹ 2,29,63,161.94 | using excel pv formulae |
Life insurance required under Need-based Method is…
Now by adding special needs life insurance and Household expenses life insurance, the total life insurance required under this method is Rs.3,038,5,500.( three crores 38 lakh approx).
Now Deduct Discretionary Assets value from life insurance required…
Deduct discretionary assets total value(excluding own house) including plots, financial assets like stocks, mf, fd etc.
Life insurance required is 30385500
Discretionary assets
value is 5000000
So, after deducting
discretionary assets
life insurance required is 25385500 (two crores 53 lakh approx).
Imp Note…
Remember if a negative value came when you deduct discretionary assets from Life Insurance required in the above step, then there is no need to take any kind of life insurance for anyone( husband and wife).
Now Wife and Husband should insure their lives based on their income ratio…
| Husband Income per year | 600000 | |
|---|---|---|
| Wife Income per year | 300000 | |
| Total Family income | 900000 | |
| ratio of Husband Income compared to total family income | 0.333333333 | |
| The Ratio of wife income compared to total family income | 0.666666667 | |
| Total Life Insurance Required is | 25385500 | |
| So, The insurance required for the wife in her name is | 8461833.333 | (84 lakhs) |
| So, the insurance needed to be taken by husband based on his income ratio is | 16923666.67 | (1.7 crores) |
Conclusion…
Finally, it is clear that insuring lives under the need-based method a good method than ensuring under human life value method or any other method.
Under need-based method, sometimes insurance is not required at all.
Imp note…
But sometimes, under the need-based method also after calculating the insurance required for life, Insurance companies will not give required insurance.
This is because insurance companies will give insurance on our life based on our income. But sometimes our needs will be more than we earning.
In that case, it is better to take life insurance in such a way that it will cover at least 10 years family gross income.
Not only this, as the family is protected for less cover. In addition, They should reduce their goals when there is a death.
Read the article about Inflation- How it decreases money purchasing power?. Click here to read.
Also, read article about Lic vs Pli. Click here to read.
read about NPS new tax benefits. Click here to read.
Also, read why Apgli/Tsgli should be modified by Government?. Click here to read.
