When I say “Cover you with Life Insurance”, I do not mean a Herculean task.
Not even a fraction of that.
Unlike a financial plan, insurance planning—being a part of it—is a very simple and less demanding task, so that you can focus on your investments and capital growth.
Yet, life insurance is as significant. It is your replacement to provide financial security for your family, in your absence.
How Do I Begin My Insurance Planning?
You may have heard, “Time is Money”.
But both—time and money—literally are the two things one needs to consider while getting insured. Time and money in the right proportion will make your insurance to be the most effective.
“I need a ‘sum’ of life cover for a ‘number’ of years”, Simple as that.
Today, we’ll learn how to find the optimal Sum Assured and Term so that your insurance plan will complement your financial plan.
1. Finding The Optimal Insurance Policy Term
2. Calculating The Optimal Life Cover
Life insurances are meant to act only as a backup plan. If you survive the insurance term, the policy will be terminated with no benefits. And your primary focus is your financial plan, not a worst-case scenario that may never happen.
That being said, let’s start with…
1. Finding the Optimal Insurance Policy Term
To put it straight, the optimal term for your insurance is the number of years between today and the year you are planning to retire.
For example: If your current age is 35 years and you are planning to retire by 60, the difference should be the optimal insurance term for you. In this case, it is 25 years.
The rationale behind this sort of calculation is very simple. Yet many of us overlook this simple idea and choose a term up to our life expectancy.
The Rationale behind Choosing Insurance Policy Term:
As seen above, life insurance is your replacement to provide financial security to your family.
By the time you retire, you would have attained or have enough savings to attain all your financial goals. And hopefully, your children will have become financially independent, too.
Moreover, once you retire, your active income stops. This means you will be paying your policy premium from your retirement corpus.
It is an unnecessary expense from your limited resource of savings.
On a side note: be sure to choose the right retirement age in your financial plan.
For example: you may have planned to retire a few years early, say at 55 years of age, in your financial plan. Just in case, if you have to extend it later due to uncertainty, your life insurance policy will expire at the predetermined date. Then, you will have to get a new life insurance policy for higher premium or spend those years with no life cover.
Think long-term, account for uncertainty; choose—not ideal—but practical retirement age.
So, have you calculated your optimal insurance policy term?
Keep it ready, because you’ll need it to calculate the optimal life cover that fits your financial plan.
2. Calculating The Optimal Life Cover
The optimal life cover for you is what we call, your Human Life Value.
Of course, it does not mean an actual value for one’s life, which isn’t quantifiable.
Here, the Human Life Value signifies today’s value of all the money you will be earning. That is the sum of your next paycheck to your last paycheck at retirement.
For example: Imagine a person, Kishore. He is 30 years old and his annual income is ₹12 Lakhs.
In that case, considering an ideal scenario, Kishore’s total earnings will be ₹3.6 crores in 30 years.
But that is not all. Nothing is ever ideal, is it?
There are factors like potential increase in your income, change in lifestyle due to change income, inflation, return on investing the insurance benefit,
We have to consider these for the Human Life Value to be as precise as possible.
Since a change in lifestyle or added financial commitments cannot be predicted, we should count them in only when necessary and during financial plan reviews.
On the other hand, return on investing the insurance benefit, by the nominee, to offset the inflation can be predicted. Years of track records show low-risk debt fund investments give an average return of 8% per annum in the long term.
With all the data in place, we can calculate the Human Life Value of Kishore as,
In the event of the insured’s death, his nominee will receive this optimal life cover. Investing this Human Life Value in a low risk 8% return instrument will fetch his nominee ₹12 Lakhs per annum for 30 years.
It will be a virtual financial replacement for Kishore.
To calculate your optimal Life Cover and Policy Term that fits your Financial Plan, use this “Life Insurance Calculator”.
The building phase of your Life Insurance Profile will be complete with the completion of this step.
But you might still face a practical challenge in finishing up.
“How do I choose the right insurance policy from the list of term plans available in the market?”
“What would define the quality of a good insurance policy?”
If you cannot seem to find answers to these questions, don’t worry. We’ve got your questions answered in this article:
Selecting the best term insurance plan also means, keeping it in the best shape.
Like your investment portfolio and your financial plan, your insurance plan needs periodic review, too. It will help to keep your insurance plan in good shape, and in turn, your financial plan.
Reviewing Of Your Insurance Cover:
Just as the insurance cover building phase, reviewing it is also quite simple and quick.
Certified Financial Planners recommend investors to review their financial plan at least twice a year. Since it does not take much effort or time, you may review your insurance plans, too.
It is much like checking if you have fastened your seatbelt before driving your car.
However, your insurance cover review is a must if there is a substantial increase in your monthly income, say 25% or more.
A breakthrough in career or promotion could bring such a dramatic increase in income. And often, it also inevitably increases expenses. It has happened to many people, and it may happen to you too.
In such cases, you will need to increase your life cover.
On the other hand, you might choose to change your retirement age in the future. Even though it is very rare, it is a possibility.
In such scenarios, you might want to extend your life cover. Reviewing your insurance plan will show, if it will still be effective for your financial plan.
Building a sound insurance cover is the simplest there is in financial planning.
Yet, many of us mix up insurance and investment—unaware of its harmful effects. If you or someone you know is still unaware—or want to get rid of those financial drains—read “Is Your Insurance Policy Hurting Your Portfolio?”
Regardless, I appreciate you for choosing to build your insurance profile by yourself.
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