Maybe you are considering buying insurance for yourself and your family.
Maybe you have been presented a set of proposals from an insurance professional.
Maybe you are just curious to know how much is the “right” amount to spend on insurance each month.
But you just want to know: What is the correct amount to spend? And that is a great question to ask.
Its possible to have heard things like: “About $200 – $500 a month, nothing more”
Or: “Spend around 15-25% of your salary on insurance”
We wish the answer would be that simple, but an absolute figure (or percentage) is not a good way to approach the matter.
It does not take into account how much you earn, what your disposable income is, what your insurance needs are, and what financial goals you have in mind.
In this article, we present a step by step method to determining how you should begin to start planning for your insurance expenses.
This is by no means the only way, but it sure as hell provides you with a fantastic starting point for discussion and customization.
After all, your financial planning is just as unique as you are.
1. Take stock of what you earn – and what your critical expenses are
This is the easiest of the 4 steps to take. If you earn a fixed salary, what you earn each month is basically the cash portion of your monthly income (Gross income less CPF contribution).
For variable salary owners, I recommend taking a 12 or 24-month average, perhaps reducing that figure by 10% to be on the safe side.
Yearly bonuses and other windfalls will not form part of this equation, they are always welcome but should not be counted on as “reliable income”. This also serves as a conservative approach to planning.
Now on to calculating your critical expenses. Note the word critical. In this context it means vital, indispensable, the most important.
So what are critical expenses?
Food, housing, transport, and recreation, these would be expenses that are considered critical. Yes even recreation! (And no, I am not being schizophrenic – I just consider recreational expenses very important.) Everyone needs to unwind from time to time.
Even though there is latitude to consider luxury costs for these expenses, we shall be sensible and consider what would be reasonable amounts to spend for these items.
Frankly, Insurance should be considered critical too, but we shall not walk down that path today.
The leftover amount of your monthly cash flow in less your critical expenses is called your pie. (if your pie is less than 0, then you might have an issue of spending sensibly. But you are a better person than that, of course.)
Let’s look to Desmond, an IT manager in his early 30s as an example.
His take home pay is 4,800 a month.
He spends $1,100 a month on food, frequenting hawker centres but occasionally heading out to Aijisen and other restaurants.
He rents a room in Clementi for $800 a month as it saves him time on the daily commute.
He drives an OPC costing $900 a month and loves building RC helicopters, to the tune of $300 a month on average.
His pie is $1,700 a month.
2. Figure out your medium and long-term goals – how much must you set aside for them?
Step two is to think about any goals that you want to achieve.
Would that be to buy a car in 3 years? To own your own place in 5 years?
To get married in 9 months? (I know of many people in that special predicament, haha!)
This is clearly demonstrated using Desmond as a fine example.
He is dating now, but not quite sure if he will get married. However, he is sure that he would like to buy his own HDB flat upon reaching 35, so as to build equity in his own house and also saving on rental.
He is keen to build his nest egg for retirement and wants to set aside $800 each month.
He also saves $700 each month for 2 long holidays every year.
For his future house, retirement plans and holidays, he sets aside a total of $1,500 each month.
(He has been working for a number of years, and will have enough in his CPF account to downpay at least 30% for a 3 room flat in Clementi. He also intends to pay off the monthly mortgage payments using CPF, so in actuality, he increases his cash flow by buying his own house – a most happy outcome)
So far so good. His pie (excess) is $1,700 a month, and he intends to set aside $1,500 a month for future goals.
3. Work out your coverage needs – how much does it cost?
Step 3 is the hardest to do – but also is the crux of the whole matter.
Now you need to work out what are your insurance needs, and importantly, how much will they cost you a month.
There is no one size fits all regime or magic number that suits people of a certain demographic.
The good news is – this task is usually done by a (competent) financial adviser. It entails taking into account any financial dependents you may have, any major liabilities that you owe, and looking at your individual lifestyle needs as a whole.
So how does Desmond fare in all of this?
He needs to get an integrated shield plan, which sets him back $480 a year in cash. Despite the improvements of Medishield Life, we firmly believe that everyone needs their own integrated shield plans to cover 100% of their hospital bills. Our related post found here.
He also needs at least 300k of Critical illness (CI) cover for the next 30 years – as medical treatment techniques improve, so does the chance of survival. Survival and treatments come at a cost, which can be offset by the CI cover.
Since he has no dependents (his parents do not require financial assistance from him, and he has no children), his need for death and terminal illness cover is minimal. He can cover CI, Death, Terminal Illness and Permanent Disability by the following means:
A Term plan lasting 35 years with a 300k cover costs $100 a month (approximately, because various insurers have different prices)
A Whole life plan with an equivalent 300k cover for all the items costs $700 a month (approximately, because various insurers have different prices)
A combination of both. We shall leave the discussion of Term Life vs Whole Life for another day!
He should also obtain some personal accident and disability cover in the event of any accident that may render him unable to work and also requiring treatment for a prolonged period of time. A standard plan costs $540 annually, with all the bells and whistles thrown in.
So Desmond’s insurance costs each month to meet his insurance needs range from:
$185 (low end)
$785 (higher end)
One last thing left to do.
If you want to address any Insurance coverage shortfalls on your own, check out FWD Insurance. They have a fully online and hassle free purchase experience.
4. Adjust and refine, as necessary
Herein lies the art of Financial Planning. Once you have worked out what you need, what you want, and how much it all costs, you need to put it all together and make it work. And there can be more than one “correct” answer, depending on each individual.
If happily for you, all the costs of step 2 and 3 work out to be lesser than your pie: FANTASTIC. The extra money can be used as you see fit.
But more often than not, we do not have enough to spend on Insurance and on our other financial goals.
So compromises have to be made.
Perhaps spend less each month?
Shop around for less expensive insurance plans?
Or re-evaluate your financial goals to see if they are realistic. A competent financial adviser will be able to help you find creative solutions to resolve the shortfall.
What happens to our hero, Desmond?
Happily for him, he has an excess of $200 each month to set aside for insurance, which is more than adequate for his coverage needs.
He decides to spend up to $500 instead, buying a Whole Life Plan as well as a Term plan, but each for smaller amounts. This addresses his coverage needs fully (split roughly 30% – 70% between both plans).
Desmond reasons that part of his retirement nest egg can also be funded by the Whole Life Plan, so he just needs to set aside $450 for retirement each month. (Instead of the original $800)
With that, Desmond is in a great financial position. He is well covered, and has enough each month to spend. Not only that, he is setting aside money each month for his future financial goals.
He then lives happily ever after. Of course.
A Parting Note
Right from the start, we pondered the question: How much should I actually spend on insurance?
Along the way, you may have noticed that the key lies in knowing: How much cover do I need at this point of time? How much would that cost me? And how do I make the two ends meet?
In trying to make the two ends meet, there can be a variety of different methods. It really depends on your risk appetite, your investment preferences, the nature of your financial goals – in short, it really depends on you.
We hope that we have provided a small leg up in this never ending journey of financial planning.
It is always a good idea to discuss all these with your financial advisor(s), and we would love to hear from you if you have your own thoughts on this matter.
Till next time!
www.ClearlySurely.com aims to eradicate the knowledge gap between consumers and Life Insurance. Our Vision is that one day, every Man, Woman, and Child will be properly insured.