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Financial Planning 4 : Analysis of Life protection plans

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One of the key ingredients of your financial life is to have adequate life protection plan. A life protection plan protects the income of your family in your absence.  These are also called ‘term plans’ or ‘pure life insurance’ since it’s the most simplest and the most basic form of insurance.The premiums are less and hence the commission earned by the seller is also less. For this reason, terms plans are least promoted by most of insurance agents.

Some people think that subscribing to life protection plan is not worth since you pay annual premium but get no monetary return at the end of the maturity period.

They miss two key points here:

  1. Insurance is not an investment. The basic purpose of insurance is protection. Money is paid for protecting the family’s income and standard of living, in case the insured person dies early.
  2. By paying the premium annually, the family is guaranteed a huge sum of money just in case the insured person dies. That would have brought a lot of peace of mind to that person. Getting relived from the anxiety of ‘what will my family do if I die today’ is priceless!

When you’re younger, it’s cheaper:

One good thing about life insurance premiums is that the premiums do not change year after year. So if your premium is 10,000 it will continue to be so till the very end of the policy period. However, the premium charged for a 40 year old not be the same as the premium charged for a 25 year old.  Young people are charged less. For example the premium for a 1 crore insurance would be approximately Rs 7500 for a 25 year old male but for a 40 year old it would be approximately Rs 30,000.  Once the premium is fixed based on the entry age, it never changes during the policy period.

When you’re older, it’s difficult to get:

Insurance companies are interested to insure young people so that their risk is minimized. That’s the reason why a 25 year old would be preferred by all the insurance companies with just basic medical check-up while a 40 year old will be given insurance only if he qualifies in all sorts of medical check-ups.

In short the critical factor that will decide how much premium you’d be paying is your age.

Life plans – 10 basic rules.

Life insurance decisions should not be solely based on how much premium you can afford to pay. There are certain basic rules to keep in mind while analysing the adequacy of life protection plans. These rules are summed up below in the form of thumb rules.

Thumb rule 1– Your life policy at any point of time should be 8 to 10 times of your annual income. So if you are having an annual salary of 10 lakhs, your life should be protected for 10 lakhs x 10 – 1 crore.

Thumb Rule 2 – Minimum policy protection required should be the total of all the loans outstanding. So if you have a home loan of 50 lakhs, a vehicle loan of 5 lakhs and personal loan of 4 lakhs, the minimum amount required for life cover would be 59 lakhs.

Thumb rule 3 – Instead of taking rule 2, there is an alternative way. Add up all the EMIs and monthly expenses.  The life plan amount should be such that the monthly interest generated if invested in a debt fund should be adequate to meet the monthly expenses. For example – if the Total EMIs you pay are 35,000 and your monthly living expenses are 50,000 you should have a minimum life cover that would generate 85,000 monthly (say at a decent rate of interest – 7% in today’s scenario).

Thumb rule 4 – The above rules were for computing the minimum coverage required. Ideal coverage amount would be 15 times the annual income + the amount of outstanding loans. So if you have a annual income of 15 lakhs with a home loan outstanding of 75 lakhs the ideal coverage required  would be  15 lakhs x 15 ( 225 lakhs ) + 75 lakhs = 300 lakhs.

Periodical review:

As you go up in your career, the adequacy of life cover should be reviewed.  If you have moved ahead in your career, it obviously means that you have improved your standard of living. Hence the life cover taken at the beginning of your career would not be sufficient to compensate the present standard of living.

Thumb rule 5– Review life cover every 5 years or when there is a dramatic increase in your income due to a successful venture or career break through.

Thumb rule 6 – Although the value of one’s life cannot be measured, insurance companies have certain benchmarks on how much a person is eligible to be covered. Life cover eligibility is decided by the income you earn. Most of the insurance companies cover up to 15 to 20 times of your annual income.

Thumb rule 7 – Take maximum eligible live cover at a younger age itself so that you need to step up only little in future. This will reduce the premiums paid.

Thumb rule 8 – Life cover premium also depends on how long you are protected. Depending on the number of years protected, the premium will be different. Ideally, protection should be until your retirement age.

Thumb rule 9 – After a certain period of time, some of you might have created adequate wealth to sustain the standard of living. In such cases the need for life insurance becomes less.  When the situation arrives where you no longer need life protection, you can simply stop paying premiums.

Thumb rule 10 – Buy life cover for your spouse too. If she is a home maker, buy a basic cover of around 10 or 20 lakhs. From the perspective of replacement of income , insuring a home maker may not make sense. But it’s always prudent to have a basic life cover. If she’s earning, you can think of stepping up the cover according to eligibility. Life cover premiums are tax eligible hence there will be tax benefits too.

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