How Much Death Coverage Do I Need?
Buying life insurance to financially protect against the event of death is almost a no-brainer. Anyone with good financial literacy knows that death coverage is the most basic foundation that needs to be in one’s insurance portfolio. However, the question is, how much coverage do you need for death? Is 5x your annual income enough? Or does it need to be 20x your annual income?
In this article, we explore the purpose of having a death coverage in your insurance planning, why you need it, and how much do you need to plan for.
What Is The Purpose Of Death Coverage?
Before you decide how much coverage you need for death, let’s first ascertain what is the purpose. As the name suggests, death coverage is to cover you in the event that you passes on. when that happens during the coverage period, the insurer will make a lump sum payment to your dependents (e.g. spouse, children).
Unfortunately, death coverage cannot be paid out to you so don’t put yourself in the picture when you plan to get one. What death coverage can do for you is to ensure that, even if your dependents were to lose your source of income after your death, the lump sum pay-out will be there to replace it.
How To Decide Death Coverage Amount?
While there isn’t a fixed formula for calculating the coverage required for life insurance. The Life Insurance Association suggested that you should aim to have approximately 9-10 times your annual earnings as basic life cover, although this would vary from person to person, having a 9 – 10x of life insurance coverage it’s akin to guaranteeing that your dependents get to receive your income for the next 9 – 10 years. This gives your dependents more time to financially transit from relying on your income to being self-sustainable while you’re gone. Plus, the life insurance coverage lets your dependent receive everything in a lump sum payment upon your death. This gives them ample finances to do financial planning for their future by possibly engaging an expert to do so.
Over here in Moneyline.SG with guidance from a financial coach & a veteran in financial advisory, he has suggested a more realistic way to work out your death coverage by looking at these 3 intents
1. Coverage for Family Expenses
The first principle of life insurance coverage is to ensure that you do not leave behind any financial burden for your dependents, that is a big NO-NO. As such, you need to think about who to prioritise in this family expense coverage. Example, if you have children and a surviving spouse, the realistic assumption here is to make sure you have the ability to earn an income until your child graduated from tertiary education and start working in order to become financially self-sustainable. However, if death were to occur and if your spouse is already working and can afford to cover some or all his/her personal expenses then you may only need to cover your part of the family expenses. If you are the sole breadwinner, then you need to consider your spouse and children household and lifestyle expenses and possibly your allowance to your parents as the family expense.
Here is a realistic formula to help you plan your death coverage on your family expenses:
Your annual family expense x number of years it takes for your youngest child to reach age 30
E.g., if your youngest child is 5 years old today, and your total monthly expense on your household and allowance to your dependents is $3,000 then the coverage can be planned as follow:
Family expense per annum: 3,000 x 12 = $36,000
Years for youngest child to reach: 30 = 25 years
Death Coverage required for Family Expense: $36,000 x 25 years = $900,000
You may wonder, why till age 30 and why annual expense? What about inflation? Here’s why:
We understand that most Singaporeans tend to have children at around the age of 30 and may likely stop by the time they reach 40, so factoring in the number of years to cover for until your youngest child reach 30 will solve and address 3 possibilities. First, by the time your youngest child reach age 30, you and your spouse would have been close to or have already reached retirement age and should have saved enough for that purpose; Second, it is likely by the time your kids reach 30 years old they should have found a stable job or may have graduated from their higher tertiary education by then. As such, we assume that your child will be working and no longer be dependant on your income and be able to provide financial support for themselves and your living spouse.
Finally, by the time your youngest child reach 30 and you’re at your retirement age, your parents may no longer be alive and if they have been relying on you for their living expense, then this part of the financial commitment is no longer applicable.
We recommend using annual family expense instead of your own income because we want a more realistic way of calculating your needs. Along with as we progress through the years as your child becomes older, your years of financial commitment towards your family should be reduced while your coverage amount remains intact, this process will even out the potential inflation of your family expenses hence why we left out inflation in this calculation.
2. Coverage for Liabilities
The first principle of not leaving behind financial burden for your dependents is to make sure that you leave your dependents with a net-zero financial situation. To put simply, it means that they don’t have to start from a negative financial position.
While assets can be sold off to cover liabilities, you may at least want to provide coverage for your residential mortgage liabilities or at least your share of it. Think about it, the last thing you want after your death is for your house to be sold off because your dependents cannot afford to pay off the instalments.
If you’re staying in a HDB flat with the loan from HDB, then this part of the equation should have been covered through the Home Protection Scheme (HPS). For a smaller percentage of those staying in private properties it’s optional to take up a private level term or mortgage reducing term to cover your liabilities, HDB dwellers may also choose to take up a private insurance and seek exemption from the HPS coverage. At the very least, by protecting your liabilities you know that your family will be in a much stable financial position when you are not around to pay for them.
3. Coverage for Legacy and Gifting
The least important reason to get a death coverage is the need to leave a legacy or gift for your loved ones or for a cause you believe in. Take note that in such planning, we are assuming your dependents or beneficiary do not actually need the money, yet you decide to bequest them a lump sum anyway.
There is no formula for this other than your personal preference. One can consider getting a death coverage as a form of legacy planning when there are assets that can be very complicated to distribute among your family members. This can be planned in such a way for example, you have three children and have 2 properties to distribute, instead of dividing the two properties among the three children which can cause many tax and legal implication, you may choose to bequest the two properties to the two children who wants to keep them and let the third child take a lump sum of cash via your insurance death coverage payout instead. This provides a less complicated way of distributing your asset and you may keep your family happier by doing so.
When is Death Coverage not necessary?
There can be only 1 reason for not getting any death coverage, you are single with no dependents and liabilities and have intention to staying that way for life then yes you don’t really need any death coverage at all. In such scenario, you may want to consider getting critical illness coverage instead to protect you from losing the ability to earn an income.
Planning Your Life Insurance Coverage Today
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This is a general guide. Often, the actual coverage that you need depends on your current financial situation. The best way to do it is to consult a professional with the right expertise to assist you. Let us know below how a licensed financial planner can help you