This seems like a season of disclosures!
After disclosing to you the stocks and mutual funds I own in my portfolio, today I discuss the amount of term insurance I’ve bought and my reasons for the same.
Buying a term insurance is one of the most important steps in your overall financial planning.
You may avoid buying any ULIP, Endowment, Money-Back, or Child Plan…but just don’t avoid term insurance.
This is especially true when you have dependents but don’t have enough assets (investments, trusts, etc.) to provide for them after your death.
However in case you have dependents and also have enough assets to provide for them after your death – a fully-paid-for home, a large and well-performing investment portfolio, frugal lifestyle – then you “do not” need term insurance.
I fall into the first category above – while I live a frugal lifestyle, I still don’t have enough assets as of now to provide for my dependents after my death – and thus I need term insurance.
Term insurance isn’t ‘life’ insurance
The most important aspect about term insurance, that most people fail to consider, is that it’s not really “life” insurance as it is generally claimed to be.
A term insurance, after all, does not insure your “life”. It will not save you from dying.
In reality, a term insurance is a “cash flow” insurance – it insures the cash flows your family would need to survive, whether you are alive or not.
How much term insurance I’ve bought?
This is how I have calculated my needs – as I mentioned above, I see term insurance as something that will replace the cash flows that I would bring to meet my family’s expenses in case I were to not die.
So if I expect my wife to survive 20 years after I’m gone (I’m keeping my children out of this as by the time I die, I’ve assumed that they would be living their lives independently), the amount of term insurance I must have is:
(20 years x 12 months per year x Assumed Monthly Household Expense in the year I die) x 1.5
= 240 months x Rs 50,000 x 1.5
= Rs 1.8 crore
Why did I multiply my insurance requirement by 1.5 in the above formula? Well, that is to have a margin of safety in case I die much earlier than expected (and thus my wife would need much greater cash flows to survive the remainder of her life).
Also, one thing missing from the above formula is any debt/loan I may have as of now (and I have zero debt as of now).
If you have, say, Rs 20 lac of housing or other loan, just add this amount to the above calculation, and you can arrive at the total term insurance you need.
So, as the above calculation shows, I need term insurance worth Rs 1.8 crore. As of now, I am still short by Rs 30 lac, which I will cover up soon.
Insurance in whose name?
I bring in cash flows to run my household, so the term insurance policies must be in my name.
Remember again, I must not get emotional here and try to insure the “life” of my wife and children, in case they are not adding to the household cash flows.
In short, term insurance acts as a replacement for cash flows, so as a rule, you should only insure people whose death would mean a financial loss to you (and it’s most likely ‘you’).
Insurance isn’t investment
You take term insurance because you consider the probability of dying within the insured period high enough, so that your dependents can get the sum assured.
But if you don’t die within the insured period (20 or 30 years as the case may be), you won’t get anything from the insurance company.
In other words, if you survive, there’s “no” return of capital in a term insurance. And thus, it must not be considered as an alternative to investments, or an addition to your investment portfolio.
Term insurance has just one purpose – to replace an economic loss. That’s it!
It’s not for education savings. It’s not for retirement savings, or to provide a tax-free loan later in life.
No matter how much term insurance you buy (or are sold), it will never replace an emotional loss.
So buy sensibly…but just buy it!