Essentially there are two parts to a typical life insurance plan – the risk protection component and the savings component. The first one is called Death Benefit and the second one, Maturity Benefit. Some plans have only Death Benefit and some plans may have only Maturity Benefit. But many plans have both components in varying proportions.
We recommend that to arrive at the right insurance amount, you need to consider the below situations -
1. Protecting your family against potential loss of income due to untimely death
The first thing you must know is whether the life insurance plan you are planning to buy has the right components in the right mix. Let's look at one situation -
- Your family is financially dependent on your income
- You have financial liabilities like home loans or other loans
- You do not have other assets to take care of your family's financial needs
In the above circumstances, you may buy a life insurance plan with a high risk protection component. The sum assured should be 6-10 times of your annual income depending on your age minus the insurances and investments you already have that can be liquidated in a financial emergency.
For example: If your
Annual income = Rs. 5 lakhs
Age = 35 years
Ideal insurance cover required = Rs.50 lakhs (Rs. 5 lakhs X 10 times)
However, if already have -
Insurance cover = Rs. 8 lakhs
Bank deposits = Rs. 5 lakhs
Total investments = Rs. 13 lakhs (Rs. 8 lakhs + Rs. 5 lakhs)
Insurance cover required = Rs. 37 lakhs (Rs. 50 lakhs – Rs. 13 lakhs)
You may go for a pure Term Plan or go for a savings plan with a high risk component that gives insurance cover of the desired amount.
2. Protecting your family against the burden of liabilities due to uncertainties
Let's look at another situation -
- You have covered yourself against possible financial crisis due to untimely death.
- You have also recently taken a home loan.
As you are young and have financial liabilities, you may take a Credit Life plan for any of your loans and add a pure term rider or take a term plan.
3. Providing for funds needed for future goals and dreams
Let's look at a third situation - you have covered yourself against possible financial crisis due to untimely death. You have also recently taken a home loan and secured yourself against that liability by taking a Credit Life Plan.
However, you need to save regularly to ensure you have enough money to meet your children's education, marriage, health and living expenses after retirement.
You need to plan several years ahead for these important financial goals for which you need to save money regularly in small amounts now. Remember it is always important to start early, save regularly and think long term.
For meeting your other long term financial goals, you should also take a savings plan separately for wealth accumulation.