Experts always recommend that the adequate amount of life insurance should be enough to protect in case of death of the bread winner. But, most of the people find it difficult and are confused about how to calculate the exact life insurance one needs to be covered with.
Life Insurance agents may give you various reasons that are sometime not so convincing in order to make you buy insurance plans. They normally always advise you to buy insurance products with an investment component.
This article will tell you how to calculate your life insurance needs correctly.
Let us now understand how life insurance needs are calculated. There are two most commonly used methods to calculate life insurance needs.
The First one (which is advocated by insurance agents) is human life value method. The other (which is correct method in my opinion) is to calculate on a ‘need based’ method.
The value of human life is calculated on the basis of income of the person to be insured till his/her retirement age. As against the human value method, the need based insurance value is calculated on the basis of day to day family expenses till the life expectancy of the youngest person in the family. One should apply need-based theory instead of going for human life value while calculating the exact need of life cover.
It is also important to buy life insurance only if one has dependent/s who are financially dependent on his/her income . If you are single/unmarried with no dependents then there is no need to buy any life insurance cover. Many unsuspecting people are made to buy life insurance policy for their wife even when she is a pure home maker. Likewise, people are induced to buy child plans with the trick of emotional blackmailing for their children’s future without understanding the cost involved in such insurance plans.
So neither, the buying of insurance for pure home maker or accumulating corpus for child is advisable. Your life insurance need will come down if your spouse is also working or to the extent of assets already owned by you. Any existing or future financial liability needs to be taken into account while arriving at the amount of life insurance you need.
The liability would include loans or any value of expenses which one will have to incur in future like education and marriage of children.
Let us take a live example to understand how to calculate life insurance need with the help of an excel application.
Mr. Ronak aged 32 years working in a software company draws a yearly salary of Rs. 6 lakhs. He lives in Mumbai with his wife aged 30 years and 2 daughters aged 4 years and 1 year. They live in their own house which they bought last year for total value of Rs. 30 lakhs. They have taken a home loan of Rs. 20 lakhs and are paying home loan EMI of Rs. 25,000 every month. The outstanding loan balance currently is Rs. 19 lakhs. He has Rs. 3 lakhs in EPF account, Rs. 2 lakhs Mutual Fund Investment, Rs. 1 lakh FD and Rs. 50,000 in savings bank account. The total investment assets are Rs. 6.50 lakhs. His monthly house hold expenses including conveyance, education, life style is Rs. 18,000. He has two endowment plans of sum assured of Rs. 1lakh each and is paying premium of Rs. 10, 200 yearly. He has some future liability in the form of Rs. 5 lakhs each for higher education of both the daughters and Rs. 2 lakhs each for marriage. He is covered under group health insurance provided by his employer for 3 lakhs under family floater. Now Mr. Ronak wants to calculate his life insurance need with the help of excel.
So he opened excel, selected formulas then insert function and clicked at PV i.e. present value. Present value function will give you a present value of all the future outflow for his house hold expenses if anything happens to him today. Let us calculate and understand the same in detail.
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