How Much Life Insurance Do You Really Need?
Life insurance is the foundation of a sound financial plan. It provides financial security for your family by protecting your financial resources, such as your present and future income, against the uncertainties of life.
More specifically, life insurance provides cash to your family after your death. This cash (death benefit) replaces the income you would have provided and can meet many important financial needs. It can help pay the mortgage, run the household, send your kids to college and ensure that your dependents are not burdened with debt. Moreover, insurance premiums are now tax deductible up to Baht 50,000 per year.
Most people with dependents need life insurance. While there is no one answer to how much coverage is enough. One rule of thumb is to buy life insurance equivalent to 5 to 10 times your annual gross income. That would mean a person making Baht 2 million a year should have anywhere from Baht 10 to 20 million worth of coverage or more. Choosing a life insurance product is an important decision, but it can be complicated. As with any major purchase, it is important that you understand your family's needs and the options open to you:
Keep your investing and insurance strictly separate
Due to the current historically low interest rate environment, people have been buying life insurance in droves because of the so-called guaranteed 4% annual return being offered by some life companies and the assumption that insurance companies can not go bust. Remember that the sole purpose of life insurance is to replace your income in case you die, so keep the two separate. Besides, there are better places to invest without the high commissions of life insurance policies.
Buy when you are young and healthy.
Older people and those not in the best of health pay steeply higher rates for life insurance. So buy as early as you can but don't buy until you have dependents.
Tell the truth.
There is no sense in shading the facts on your application to get a lower rate i.e. lying about your smoking habits or nature of your professions. Be assured that if a large claim is made, the insurance company will investigate before paying.
Don't be underinsured.
Life insurance policies with an investment component cost more due to embedded sales commission. As a result, many people can't afford an adequate face value, leaving themselves underinsured. But buying life insurance is no place to be stingy. Do shop around for the right policies that match your needs.
Now let's turn our attention to determine how much, if any, insurance you really need. The answer isn't really how much life insurance you need…. it's how much investment capital your family will need at the time of your death. Their need for capital is really a function of two variables:
How much will be needed at death to meet immediate obligations?
The first answer is fairly easy to estimate. It's the sum of final expenses such as uncovered medical costs, funeral expenses, estate-settlement costs and other lump-sum obligations like outstanding debts, mortgage balance and college costs.
How much future income is needed to sustain the household?
The second variable is a bit trickier. It involves calculating the "present value" of future needed cash flow streams.
An example below is designed to give you a closer estimate of how much insurance is needed.
| Lump Sum Needs at Death: | |
| Funeral & uncovered medical expenses: | Baht 2 mm. |
| Outstanding debts: | Baht 1 mm. |
| Mortgage: | Baht 5 mm. |
| College funding: | Baht 2 mm. |
| Total lump sum needs: | Baht 10 mm. |
| Present Value of Income Needs*: | Baht 11.46 mm.
|
| Total Capital Needs (in the event of your death): | Baht 21.46 mm. |
| Deduct Current Investment Capital: | |
| (including savings and provident fund) | Baht 8 mm. |
| Net capital Needed: | Baht 13.46 mm.
|
| Existing Life Insurance: | |
| (including individual policies and company group life) | Baht 5 mm. |
| Your need for additional life insurance: | Baht 8.46 mm.
|
* Analysis of present value of income needs:
|
|
- Monthly income needed for surviving spouse:
|
Baht 50,000 |
| - Number of years: | 20 |
| - Estimated inflation rate: | 3.5% |
| - After-tax investment return: | 4% |
Based on the above example, you need an additional Baht 8.46 mm. of life insurance. Should you die, the financial impact on your dependents is the loss of your income as well as the immediate expenses associated with your death. The death benefit offered through life insurance serves as replacement income for a period of time to help your family build a more financially secure future.
How long a term?
The secret to buying a policy with the right term is figuring out how long you need to be insured. You can start by estimating when your children will be out on their own and no longer in need of your financial support.
So if your children are 3 and 5 years of age now, you would probably want a policy that covers you at least until your youngest child is 22 years old, so that's about 20-year term. But this also depends on your age as well.
If you want to cover your spouse for your lost income until what would be your normal retirement age (65) and you are only 35 now. Then you would want a 30-year policy.
However, keep in mind that insurance gets very expensive once you are 50 and over. So you will pay more to cover yourself until you are 65, even if you lock in a level-term 30-year policy. In fact in Thailand coverage past age 60 is unattainable.