How Much Life Insurance Do You Really Need?
Everyone needs insurance, whether you are a young working adult, a new parent, a home maker or a retiree.
According to the LIfe Insurance Association (LIA) Singapore, mortality protection gap represents the financial gap to cover dependents’ needs such as outstanding mortgage and car loan, children’s needs such as education savings and living expenses and funeral costs over a definite period in the event of death.
It estimated that the average protection needs against death of a working adult with at least one dependent amounts to roughly 9 to 10 times the person’s annual earnings. This, of course, will vary from person to person.
It also says that people need coverage to provide for family needs during the assumed recovery period of 5 years
for a critical illness or until the insured person can return to work or adjust his lifestyle needs. But Singaporeans have only met a fraction of this.
Quantifying Your Life Insurance Coverage: Death Benefit
How do you calculate the loss of economic life value or human capital? How much life insurance do you and your family need?
Being underinsured is a risky situation - in the event of an unforeseen accident or illness, you can lose the ability to work for an extended period of time. Needless to say, this has repercussion on your finances.
The Simple Rule-of-Thumb
In the past, this quick and easy method is used to determine death needs. You multiply your annual income with a factor ranging from 10 to 15. For example, if you earn $80,000 a year and a factor of 10 is used, this works out to $800,000.
But this is too simplistic given that there are other important considerations. What about the ongoing living expenses of your spouse, children and parents, future obligations when you are no longer around to provide for them? Hence, a more comprehensive approach needs to be used to determine death benefit.
The More Realistic Computation
This is a systematic way to derive your death insurance needs. It is mathematically sound and best of all, it takes the guess work out of it. There are 2 things to consider here: your financial obligations to your dependents and your current resources.
Part 1: Financial Obligations
This could include:
b. Future living expenses of your dependents
- Car loan
- Personal loan
- Outstanding income tax
- Unpaid credit card bill
- Funeral expenses
If you have no dependents, then there is no need to plan for this provision. However, if you have dependents, you would need to determine their living expenses so that they can still maintain the same standard of living after your demise. This amount will be multiplied by the number of years to support them till.
For example: You currently contribute $4,000 to your family’s expenses and you give your parents a monthly allowance of $1,500. You estimate that you will continue contributing for another 15 years until your kids join the work force. As for your spouse and aging parents, you assume their life expectancy and calculate accordingly.
c. Child’s university education
As the cost of education increases with time, it is prudent to start saving early. How many children are you supporting? What field of study (medicine or non-medicine) would you like to set aside money for and do you wish to plan for 3, 4 or 5 years? If you intend to get education savings plans for this purpose, then you need to factor in the premiums.
d. Lump sum gifting, if any
It is not uncommon for people to gift a lump sum to his or her favourite charity, loved ones and even beloved pets.
e. Tally up your death insurance needs
Once Part 1 is completed, you can tally up by adding sections a, b, c and d to derive the amount of death benefit you require.
Part 2: Your Available Resources
If you need $1,000,000 to provide for your dependents and you already have the resources to do so, then you need not get any more life insurance (death benefit). However, if there is a shortfall, it is recommended that you close the gap immediately.
I would like to highlight that even in situations where available resources are greater than the protection need, I would still advise that you transfer the risk (partially or even 100 percent) to the insurers. Why would you want to exhaust your resources and self-insure when it is more cost efficient for the insurer to take over the risk?
a. Your available resources come from:
Your existing insurance coverage
Consolidate and note down the coverage you have from:
Your current assets
- Your own insurance policies - for example, Dependent Protection Scheme (DPS by CPF), Home Protection Scheme (HPS by CPF)
- Your policies bought through insurance agents and banks
- Your employee benefits (company insurance)
They are typically your:
b. Shortfall or surplus in your life insurance needs?
- Bank savings
- Fixed deposits
- Investments - for example, shares, unit trusts, investment property
- CPF monies (balance of Ordinary, Special and Medisave accounts)
Once you have added up all your available resources, you can then determine if you have a shortfall or a surplus in your life insurance needs.
Quantifying Your Life Insurance Coverage: Total & Permanent Disability Benefit
What happens if you become permanently disabled from a car accident? How much would you need to support yourself and your dependents?
Most people would give me a blank look because they have no real answer to this.
The truth is, besides the usual living expenses, there will be additional medical related expenses to take care of.
A disabled person would need medication, regular medical consultations, regular rehabilitation sessions or therapies and a caretaker to watch over him. And not to mention there would be medical bills to pay off as well.
Here is a list of possible monthly living expenses if you suffer from a permanent disability:
- Medication ($100)
- Maid/nurse ($1,000)
- Medical consultation ($400)
- Rehab therapy ($600)
- Transportation ($200)
- Initial lump sum to tide over immediately after accidental event ($100,000)
The additional monthly expense works out to $2,300. I would say this is a conservative estimate - your monthly expenses and initial lump sum for treatment are expected to be much higher. Also, think about the possibility of living another 10 to 20 years.
Karen’s Opinion: Be On The Safe Side. Protect Your Wealth Before You Invest.
Wealth protection is fundamental in helping you weather unforeseen circumstances that would otherwise have a detrimental effect on your long term financial wellbeing.
Just remember that it only takes one accident or a major illness like cancer to deplete your life’s savings. Don’t simply choose the cheapest policy available or dismiss insurance entirely. The right amount of coverage and the right type of solutions will stand you in good stead.
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