Landed your first job? Buy a life insurance policy, your relative or friendly neighbour might tell you.
However, while life insurance is indeed critical, and ought to be among the first steps in the journey to secure your financial future, several factors need to be taken into account before buying one.
To start with, it is best to avoid buying a life insurance policy if you do not have dependants—a life cover is, after all, primarily meant to replace the breadwinner’s income in the event of his or her demise to protect their family members’ financial interests and goals.
Secondly, avoid buying insurance-cum-investment policies when your goal is to protect your loved ones against income loss in your absence.
Also read: Why term insurance premium rates are cheaper for higher sums assured
Is life cover of 10-times your annual income enough?
Once your evaluation shows that you indeed need a life insurance policy to secure the financial future of those who will be affected by the loss of your income, you can set out to estimate the ideal cover amount. You can compute this amount by using scientific methods such as human life value (HLV) or income replacement.
But to make it simpler for lay individuals who may not have the time or wherewithal to arrive at the correct number, financial planners often refer to a thumb rule—your life cover ought to be at least 10 times your annual income. While the emotional loss is irreparable, the policy amount paid out will ensure that your dependants have sufficient time to recover from the monetary loss.
However, the argument against this thumb rule is that it is way too simplistic and could result in people ending up with inadequate cover, which means that it will not help achieve the goal of ensuring that your family is secure despite your absence.
For example, this cover will not be adequate if, say, you have a large housing loan to be repaid. Also, if your plan is to send your kids to study abroad, a life policy that only replaces your ten years’ future income will not suffice. The claim amount may instead be sufficient to only meet regular household and other living expenses during the period.
Also read: Term insurance: A delay in buying can cost you dearly
Thumb rule not a substitute for meticulous calculation
Therefore, you need to carry out an in-depth study of your requirements. Put simply, your term policy should be adequate to replace your income, take care of your family's living expenses, pay off your debts, including home loan, and provide for your family’s future financial goals, particularly children's higher education, in your absence.
Finally, make sure you review your term insurance cover every five years, or at least after any change in life stage. For example, you should consider reassessing and possibly enhancing the sum insured once you have children.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
