Tuesday, August 18, 2009

Secure Future Income

Insurance can be a long term commitment so it could be very costly to commit into one without having a clear goal in mind. Each of the insurance you own should have a meaningful purpose, else you may not get back what you have sacrificed for. One of the purposes for buying insurance is Income Replacement.

As straight forward as it may sound, there is NO standard way of calculating how much is needed. Below shows one example ...

You are 25 years old and earning $2,000 now. If you want to secure that income up to age 55, that is 30 more years to come. Linear sum would be 2,000 x 12 x 30 = $720,000. If you also think you can get an average of 5% increment every year, then your total future income is about $1.6 millions.
If these numbers seem big to you, then perhaps your personal finance consultant or even yourself have been misleading yourself in your needs assessment. Calculation above isn't exactly rocket science.
If you have set a 10% budget or $200 per month, then what you are looking for is to buy $300 insured value with your $1. ( $720,000 / $ 200 / 12 months = $300 ). This pretty much mean your only choice is Group Term Insurance. Within the same budget, other types of insurances may only provide an insured amount of $100,000. Which is less than 14% of your $720,000 needs.
The simple and straight forward part of insurance consideration is just that, you should get a Group Term Insurance for this purpose. However, should you still not satisfy with that ... you may analyse further ... into the no-that-simple or the fun part
Your income replacement needs is actually reducing as the years go by. For example, 10 years later, you would have already earned some of your income and your needs from age 35 to age 55 is only 20 years or $480,000, no longer $720,000. Likewise, when you reach age 45, your need will reduce by another one third. According to this, a Reducing Term Assurance may be suitable too ... which is also very cost effective.

If $720,000 is still not an affordable sum, you may need to re-assess your needs ... before simply limiting it.

Why do you want to secure your future income? Is it because you worry about your parent's living expenses ? If yes, how much do they really need ? If it is NOT $2,000 a month then perhaps you should secure your parent's future living expenses and not really the whole of your income.

Or are you just planning to maintain your life style? If yes, then you most probably do not need to pay income tax and EPF with your insurance payout. Hence that may comes up to about 15% saving. So intead of $720,000 you just need $612,000 for this purpose. Like wise, what exactly is the life style you are trying to keep ? Are any part of your current income form another part of saving ? Is that saving a part of the lifestyle you want to keep ? If not, then you may further reduce the sum of this need.

If whatever amount you come up with after re-analysing your need is still HIGH, then perhaps 30 years is too long a plan for you. You may want to secure your next 10 years income first. So to secure your income up to age 35, its only $240,000. With the clear concise mind that your age 35 to 55 is NOT secured. You better work something out before you are age 35 ...

Lastly, don't be confused by the dualism. Insurance can be an option but securing your future income does NOT necessary have to have insurance. ie. its not the only way.

The whole idea of you securing the income is that you are assuming the income needs to be secured when you stop working. In another words, your current income is an active income. You work you get paid, you stop payment stops. If future continous income is important to you, why don't you start by focusing on getting passive income instead ? That way, no matter if you are here or there, income keeps coming and you don't need to pay extra to secure any of it ...

don't forget Personal Finance is NOT all about money, sometimes it just takes a little bit of creativity ...

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