Choosing the right amount of life insurance is an important part of creating a sound wealth plan that takes care of your dependents even if the worse should happen. Arriving at the right number can be challenging because it requires not just financial analysis but ample introspection. In some ways, deciding on the right level of coverage is a life decision as much as it is a financial one.
Some will tell you that you should simply buy a multiple of your income, others may pluck a round number with six zeroes out of the air, and still others may run some quick calculations to determine how much you need to create an estate of any size you desire.
With these differing approaches, how should you decide how much life coverage you need? Here are some handles on how to make a considered decision.
1) Understand that life insurance is part of a contingency plan, not the main plan
We should first be mindful that life insurance is for contingencies. It is a tool to ensure that our loved ones are taken care of if we meet with an unfortunate, and unexpected, early demise. In that case, everything that we wish we could have done for them financially, over our lifetime, is turned over to our estate (bolstered by our life insurance payouts). In the best case, though, we never need to make the claim before our wealth accumulation plan has played out and we have enough to take care of them while we are still healthy. Knowing this, we should be mindful that insurance is an expense, the cost of which should be kept as low as possible for the necessary coverage that it may provide.
2) Consider your entire future estate, not just your sums assured
To avoid over-insuring yourself, remember to also take into account the resources that you have already accumulated (net of liabilities, of course), before filling the gap with insurance coverage. As you build up your nest egg, your need for insurance decreases because your dependents can use those resources in your absence too.
3) Have a clear vision of what you would like for their life to be like
Instead of just choosing a lump sum amount that you think may be a nice gift for them to have, imagine vividly the kind of life you would like for them if you really were gone.
What kind of lifestyle would they live? Where would your children go to school? Would your spouse start or continue working? Would you like them to be debt-free? Does your original wealth plan need play out fully in the same way as if you were alive? Or will they adjust to something a little different?
Such questions can help you define what is most important that you provide for and determine what is enough as pertains to the size of your future estate.
4) Weigh the cost and factor in some flexibility
Of course, our wishlist of things we want our loved ones to have comes at a cost, so it is important to weigh that against what you would be sacrificing today in your main plan by spending on life insurance.
For example, you may not always want for your current wealth plan to go fully undisturbed in the face of the loss of your own life – because being only a contingency plan, if you are confident in your loved ones’ ability to thrive and you know that they can adapt, then perhaps you may only need to provide enough to ease the transition to a new state of things rather than an excessively large payout that covers everything they will ever need.
A nuanced conversation or thought process is needed
Quite often buying life insurance is more than just following rules of thumb or number crunching. It involves exploring your money values, what is most important to you, and a balancing act between the life you want for your loved ones when disaster strikes and the cost of ensuring they will have it.
That is exactly where gentle guidance, and deep conversations with people whom you trust really matter.
This is an original article written by Bryan Chan, Client Adviser at Providend, Singapore’s First Fee-Only Wealth Advisory Firm.
For more related resources, check out:
1. Money Advice for My Younger Self
1. Is Your Financial Adviser Worth His Salt?
3. Why Buy Term and Invest the Rest Is Not the Whole Story
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