Life Insurance Planning- How much insurance you required under need-based method?
Life insurance planning is very important in insurance planning. In addition, there are two methods that you can plan to take a 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 that is good to take in life insurance to protect dependents 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 members should take life insurance.
What is the need-based method in life insurance planning?
Earning members in the family will have some financial goals and commitments: life child higher education, child marriage, dependent expenses loan clearance, 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 a 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.
The 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 it.
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, when we will die is uncertain.
If there is no need for life insurance, that means there is 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 the need-based method. The steps involved are…
- Analyze the present value of the total loan balance that you have to pay, including home loan, personal loans, business loans, vehicle loans, 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 dependent expenses (spouse, parents, or both).
- Sum all the above values, and this is the life insurance required for you. But you need to deduct discretionary asset value from this value.
- Calculate the discretionary assets total value like physical assets like lands, buildings gold, etc. own house) and Financial assets like bank fixed deposits, stocks, mutual fund investments, and other deposits
- Then deduct your discretionary assets total value from the insurance required value arrive in point number (4)
- Then calculate the the 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% of total family income.).
- Imp note: You need to deduct existing term life insurance from the value arrived at in the above step.
Let’s do the calculation of required life insurance under this method with an example…
Mr. Ravi (age 32) is earning 6 lakh per annum and his wife Suchita (age 30) is earning 3 lakh per annum.
This family has a 5 lakh car loan and a 2 lakh personal loan, and this family owns 1 plot in Bangalore, which costs 30 lakh and 20 lakh in mutual fund investment.
This family has the following financial goals…
- They want to buy a house after 5 years, and the cost of such a house in today’s cost is 35 lakh, and inflation expected is 7%, and the risk-free return expected is 6%.
- They have a boy child (present age 1 year), and they want to plan for the child’s higher education at age 18. Inflation expected for this goal is 10%, and the risk-free return expected is 6%.
- This family’s 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. The inflation expected for this goal is 7%, and the risk-free return expected is 6%.
Let’s calculate each goal’s present value to do life insurance planning for this couple…
Step 1) Total present value of 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 the 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 asset 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 lakhs, approx.).
Imp Note…
Remember, if a negative value came when you deducted discretionary assets from the 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 the 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 is a better method than ensuring under human life value method or any other method.
Under the need-based method, sometimes insurance is not required at all.
Imp note…
But sometimes, under the need-based method, after calculating the insurance required for life, insurance companies will not give the required insurance.
This is because insurance companies will give us insurance on our lives based on our income. But sometimes our needs will be more than we earn.
In that case, it is better to take life insurance in such a way that it will cover at least 10 years of 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 an 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 the government. Click here to read.
and read why one crore term insurance you should not take?…
Also read about when a high ROI is required to recover the loss in capital.
And read Why buying a house with a loan is not good?
