You will be able to calculate life cover from the costs your dependants would face rather than a rule of thumb.
When Ryan first talked to Jun Hao about life cover, he used a rule of thumb: about ten times your yearly salary. Jun Hao earns around S$90,000 a year before CPF, so the answer came out at S$900,000. It sounded scientific. Then Jun Hao's colleague Nadia, 28 and single, heard the same rule from a different adviser and was told she needed S$650,000. Nobody depends on her income except her parents, who receive S$500 a month from her and have their own flat and savings.
The rule gave both of them a big round number. It couldn't tell either of them whether that number was right, because it never asked the questions that decide it.
A multiple of salary assumes that what your family needs is proportional to what you earn. It ignores three things that matter far more.
The first is who depends on you: a parent of a toddler and a single person with no dependants get the same answer at the same salary. The second is what you owe, since someone with a large joint home loan has a different need from a renter with no debt. And the rule takes no account of what you already have, such as savings, CPF, existing policies and schemes like the Home Protection Scheme, which can cover a large part of the need before you buy anything.
The method in lesson 4.2 of The Singapore personal finance system, end to end, Term life: replacing income for people who depend on you, starts from needs instead. This lesson builds on it and adds the refinements that lesson left for later.
Needs-based cover is a sum assured worked out from the money your dependants would actually need if you died, rather than from your income. You build it from three blocks.
The first block is ongoing support. For each person who depends on your income, work out how much a year they would need from you and for how many years, then multiply the two. If your partner earns, count only the part of the household's spending that your income pays for, because their income continues.
The second block is debts you'd want cleared. The usual one is the home loan. Use what the family would owe if you died tomorrow, which after a few years of repayments is less than the amount you first borrowed.
The third block is large future costs you would have paid for, such as a child's university education or a parent's care. Use a sensible estimate and write down the assumption beside it.
Add the three together and you have the gross need. Lesson 2.2 subtracts what already covers you.
Every figure here is an example made up for the lesson.
Jun Hao's household spends more than Mei earns, and the gap that his pay covers is about S$3,500 a month, or S$42,000 a year. He wants that support to run until Elise, now two, is 22, which is 20 more years. S$42,000 times 20 is S$840,000.
Their HDB loan has S$280,000 outstanding, in joint names. He adds the full S$280,000 for now; lesson 2.2 looks at how much of it the Home Protection Scheme would clear.
For Elise's university costs he sets aside S$80,000 as an estimate, knowing it could turn out higher or lower and that he can revise it when she is older.
Gross need: 840,000 plus 280,000 plus 80,000 is S$1,200,000. That is more than the salary multiple gave him, and every line of it is something his family would face.
The simple multiplication assumes something you should know about. If the family received a lump sum and spent S$42,000 a year from it, prices would rise over 20 years, so they would need more each year. Meanwhile, the money they had not yet spent would earn something in a bank or a fund.
When the return on the money roughly matches inflation, the two effects cancel, and support times years is about right. If you assume the money would earn more than inflation, you need less. Jun Hao ran it at a return 1% a year above inflation, with each year's support taken at the start of the year, and got about S$765,000 instead of S$840,000. A return closer to inflation brings it back up towards S$840,000.
He kept the simple figure. It builds in a margin, it's easy to explain to Mei, and a family grieving and under pressure is unlikely to invest a payout with much skill. That's a judgement, and you may make a different one. Write down which you chose.
The partner's income works the other way. Jun Hao has already counted only the part of the household budget his pay covers. If Mei might stop work to care for Elise after his death, or work fewer hours, the support figure should be higher. Ask your partner, rather than assuming.
Nadia's version is short. Her parents would lose S$500 a month. If she wanted to cover that for ten years, that's S$500 times 12 times 10, which is S$60,000. She has no debt anyone else would inherit, and no children. Her need is S$60,000 at most, before subtracting anything she already has, a long way from S$650,000.
Someone with no dependants and no shared debt may need little or no life cover. For people like Nadia, cover for illness and for losing their income matters far more, and modules 5 and 6 deal with those. Her life cover need will change if she marries, has children or takes a joint loan, which lesson 7.4, When to review your cover as life changes, comes back to.
The activity asks you to write the raw ingredients down before any arithmetic. List each person, the support they'd need each year and for how long, then the debts that would fall on them. Getting the list right matters more than the sum.
List everyone who depends on your income, the yearly support each needs, for how many years, and the debts that would fall on them.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).