Written by Singlife | 24 Oct 2018 |
Regardless of your age and life circumstances, everyone needs life insurance. Life insurance can help protect your loved ones against the unpredictability of life, and give you peace of mind that their financial needs will be taken care of in the event of your untimely death.
The question that trips up many consumers is, how much life insurance do I actually need?
While it’s best to seek professional advice in order to get a thorough assessment of your financial situation and needs, here’s some advice on how to calculate how much life insurance you need.
A quick rule of thumb for measuring your life insurance needs is to multiply your current annual income by a factor between 10 and 15. For instance, if you earn $50,000 a year, you would require about $500,000 worth of life insurance benefits in the event of death.
However, this method is very simplistic and assumes a one-size-fits-all approach. It doesn’t take into account your assets, your family circumstances or any future obligations.
Here’s a better starting point for estimating how much life insurance you need.
Generally speaking, life insurance is used to fill in the gap between your long-term financial obligations and your wealth and assets. The payouts from your life insurance policies can then be used to take care of you and your family’s financial needs in the event of illness, permanent disability or death.
When considering life insurance coverage, the difficulty comes in determining both your financial obligations and your assets, in order to come to a reasonable estimate of the difference between them.
Here’s a simple step-by-step way to calculate these.
What financial needs would need to be taken care of, in the event of your untimely demise? Here are four things to consider.
a) Living Expenses for Your Dependents
A dependent is a person who depends on your income for his or her living expenses. If you are married with children, your spouse and children would be considered dependents. If you also financially support your parents or other family members, they would be your dependents as well.
Taking into account their current lifestyles and/or how much you contribute to their expenses, calculate the annual costs of their living expenses. Then multiply that by a suitable factor.
For instance, when it comes to your partner and children, consider the number of years they would need financial support. When it comes to parents, take into account the average life expectancy.
Here’s an example. Let’s say your family’s monthly expenses are $4,000, and you’d like to support them for 20 years, until the approximate time that your children start working.
$4,000 x 12 months x 20 years = $960,000 in life insurance benefits
b) Children’s Education Needs
If you’re a parent, your children’s education is probably a priority. With the rising cost of education, you may want to provide them with a financial start so that they won’t need to take on large student loans to pay for their education.
To calculate your children’s education needs, look up tuition fees and multiply that by the number of children you have. For instance, the estimated course fees for a 3-year course at NUS is $27,000. Assuming you have two children:
$27,000 x 2 children = $54,000
c) Outstanding Debts
Another component to cover is your outstanding loans. Most people do not want to pass on their debts to their dependents or beneficiaries, and life insurance can be used to cover these costs in the event of your demise.
Be sure to include any outstanding loans that you are still paying off. This can include your mortgage, car loan and other personal loans that you are servicing.
You may also want to include funeral costs here.
d) Any Lump-Sum Benefits for Beneficiaries
On top of your financial obligations, another element to consider is if you’d like to leave any lump-sum amount to your beneficiaries. This could be a gift to your loved ones or even a donation to charity.
Once you’ve listed the above, add all of them together to get the final tally of your financial obligations.
Once you have a clearer estimate of your financial obligations, the other half of the equation is to calculate your assets and resources. This tells you what you already have in order to take care of your financial future.
There are two essential components in this category.
a) Your Assets
Your assets include your income, investment and dividends, rental income as well as any savings you may have accumulated.
You may also want to include your CPF balance as part of your assets, as your dependents will receive this money upon your death.
b) Any Other Existing Insurance Coverage
Don’t forget to include the coverage you already have in existing policies. This could be your own personal policies as well as national schemes such as the Dependants’ Protection Scheme.
If your company provides you with coverage under their group insurance, you can include that amount as well.
Now that you’ve listed out both your financial obligations and assets, simply subtract (2) from (1). The shortfall, if any, is the amount of life insurance coverage you need.
Depending on your coverage needs, financial goals and budget, there are various types of life insurance to choose from, whether term or whole life or endowment policies.
You can learn more about these types of policies by doing your own research or by seeking the advice of a financial planner.
If you do already have enough assets to pay off your outstanding debts as well as the costs of dying (funeral and burial costs, etc), then life insurance may not be a necessary expenditure for you at this moment in time.
However, most life insurance is also able to cover permanent disability as well as the onset of critical illness – two instances that can be a huge financial drain.
This type of insurance coverage is valuable for single people without dependents, as they would be an income replacement in times of illness or incapacity to work.
Talk to somebody
Once you’ve come up with a rough estimate of your life insurance needs, have a discussion with your partner or family members. Do the numbers make sense? Is there anything that you might have missed? Would your family require full income replacement or only a partial one?
Why consider term life?
You may think that buying insurance is not affordable, however, that is untrue. There are options that can fit a smaller budget. For instance, if you’re the breadwinner and you’re most concerned about taking care of your family’s living expenses in the event of your death, term insurance may be the best option for you. Term insurance has lower premiums compared to life insurance policies with a savings element.
Term life is just one part of your retirement plan
It’s important to remember that life insurance shouldn’t exist in isolation; ideally, it should be part of a larger financial plan. Don’t forget to consider other needs such as retirement, health and medical expenses, and savings.
Don’t skimp on coverage, as it’s better to have more coverage than less. The truth is that most people don’t appreciate the value of insurance until something tragic happens. Moreover, with the rising costs of living, it’s likely that your expenses will rise as well. What you’ve budgeted for today may not be enough 10 or 15 years from now. Having a cushion will help hedge against inflation and higher costs of living in the future.
All eggs in one basket or to spread it out?
Consider investing in a few small policies instead of one large policy. This gives you the flexibility to increase or decrease your coverage, depending on your changing life circumstances. Doing so can help reduce your total costs while ensuring that you remain sufficiently covered.
Reexamine your financial needs from time to time
Don’t forget to reassess your financial needs from time to time. Life is never static, and it’s important to revisit your past financial decisions to evaluate if they are still sound. You can consider having a review every three years, or perhaps even using milestones such as the birth of a child as the impetus to reassess your financial standing.