We buy life insurance policy with a wise intention. But do we tell our family how to use life insurance money?
Life insurance money is the fund received from the insurance company as a part of death benefit.
This is one fund whose good or bad utilisation can make or break a family.
Hence it is of paramount importance to know how to use life insurance money in a wise way.
The way one cannot mess around with the retirement fund, similarly life insurance money needs special handling.
This becomes even more important in case of death of the bread earner of the family.
So lets see what options we have in our hand to wisely utilise the death benefit fund.
First things first…lets ask some key questions?
#A. Who is going to use life insurance money?
Insurance company will handover the death benefit in lump-sum to the family. But who is going to use this money?
There can be several variations here. But I will talk about a case which is more sensitive.
- A dependent spouse.
- Children who are still studying.
- Aged parents.
This is a typical case of a family which has lost its main bread earner.
For such a family, life insurance’s death benefit fund comes as a huge saviour.
But receiving fund is one thing, utilising it wisely is another.
It is not necessary that the life insurance money always gets utilised properly. Bad utilisation of this money is not necessarily because of wrong intentions.
In majority cases, it happens unknowingly due to lack of know how.
It was the bread earner (who has died), does all the money management for the family while he was alive.
Now the main money manager has gone.
The other members of the family (specially spouse and parents), has lost the touch of managing money on their own.
No points for guessing why there is a high chance of miss utilisation of life insurance money by the diseased’s family.
So, it is important to ask this question (#A) while buying a life insurance policy.
Depending on the answer, necessary preparatory work must also be done by the policy holder.
What type of preparatory work?
Making the family members realise how to manage/generate money to run the house.
#B. Let your family know where and how they are spending money?
It is easier said than done. Why?
To tell your family where they are spending money, a report must be prepared.
To prepare such a report, one must have recording of ones expenses.
Simply recording expenses will not help you prepare a good report.
You will need to do the following first:
- Prepare a Expense-Budget Format in Excel.
- Start recording all expenses.
Needless to say that this job is not easy.
It becomes more difficult because we have not developed this good habit.
But in the interest of the family, one must start to do it from the day one, one buys a life insurance policy.
Objective is to FIRST make your family aware where and how they spend money. And then hand them over the life insurance fund.
This way they they are more likely to use life insurance money in the best possible way.
Read this blog post on building a nice expense budgeting tool in excel.
#C. How to use life insurance money?
In case of death of the family’s bread earner, its a period of terrible shock.
On once side there is a trauma of losing a loved one.
On other side there is an increasing concern of “what next?”.
The bread earner of any family is the main supporting pillar of the house.
Loss of such a pillar pose big threat on the survival of other members of the family.
What can be done for such a situation?
- Arrange for funds.
- Psychological preparation.
Life insurance policy with a suitable cover will take care of the funds (money part).
Making family aware of where and how they are spending money will take care of the needed psychology required to handle the after effects of loss/death.
Once the life insurance money is in hand, and the family knows that this money cannot be spent needlessly, what next to be done?
This is what we will answer in this article…
#C.1 Pay the outstanding credit card bill first
Why credit card bill first?
Because this is the costliest debt.
Just to understand how costly is this debt, lets compare it with an other debt.
A home loan charges an interest of 9% per annum in India. But a credit card will charge a whopping >30% per annum.
Hence it is only prudent to pay-off all credit card bill before its due date.
I know it is tough to think about credit card bill in such hard times of loss, but its better be done as early as possible.
#C.2 Make all outstanding loans zero
Generally a family can carry following types of loans:
- Home loan
- Car loan
- Personal loan
- Education loan
Do some number crunching. Add up the outstanding balance of all loans which are currently active.
Use the life insurance money to pay-off 100% outstanding balance.
Target is to become debt free in all respect.
In case the life insurance money is not sufficient to pay-off all debt, make a compromise.
Out of all the loans, home loan is the cheapest loan.
Pay-off all the balance loan (car, personal, education etc).
Then try to reduce the home loan outstanding by at least 50% by making a prepayment.
Ask the bank to use the prepayment amount to reduce EMI of the loan.
Do no go for loan tenure reduction.
Read this blog post on prepayment of home loan to reduce EMI or tenure.
#C.3 Identify all essential expenses
This is one activity which must be done as early as possible.
Remember the report we discussed in #B above.
This report talks about all expenses the family is incurring in a month/year.
But all expense line items are not essential to manage a living.
Hence screening out the essential expenses from other will be helpful. How?
Essential expenses are those expenses which will continue to incur no matter what may come.
Few example of such expenses are as below:
- Bills – Electricity, water, telephone, internet, DTH etc.
- Fees – School, bus, books, uniform etc.
- Food – Grocery, cooking gas etc.
- House help – Maid, Dhobi etc.
- Transportation – fuel for car/bike etc.
Try to prepare a monthly budget for all these essential expenses.
Suppose the total budget to manage all these expenses comes out as Rs.25,000 per month.
Separate out 6 months worth of essential expenses (Rs.25,000 x 6) from the life insurance money received.
Keep this money in a separate bank account. Use it to manage your essential monthly expenses for next 6 months.
This will give some kind of emotional support and comfort for at least next 6 months.
This data will also prove very handy while finalising the investment options later.
#C.4 Invest money for income generation
At this stage you have the following To-Do’s already ticked:
- Credit card balance is zero
- You are debt free (almost).
- You have taken care of essential expenses of life for next 6 months.
After doing all this, you must have some spare life insurance money in your hands.
Divide this money into two parts:
- 80% – Invest this money to generate monthly income.
- 20% – Keep this money aside as emergency fund.
Read this blog post on where to keep emergency fund.
Now this is a very important decision to make.
Where to invest money for monthly income generation?
This monthly income should not only suffice all monthly expense requirements (essential plus others), but also give some surplus in hand.
Read this blog post on where to invest money for income generation.
I must admit that this is not an easy decision to make.
There will be people around you who would confuse you with their suggestions.
I will recommend you to listen to everyone but do only that in which you are comfortable.
If your investment know-how is limited, my suggestion will be to put the money in bank’s fixed deposit.
The interest generated by this fixed deposit shall be credited each month in your bank account.
This will be your income.
Note of Caution about FD:
Yield of fixed deposit (FD) is low. Hence monthly income from FD’s will also be low.
But FD is still a better option to invest, when ones know-how about investment is limited.
At least one will not lose the invested money.
Moreover, during this phase of turmoil, it is necessary to first allow the dust to settle.
Take your time.
Take only those decision which are essential and within your comfort zone.
Over a period of time, increase your know-how of investment. Then try to divert a part of your FD money into high yield investment.
But I strongly believe that, for a novice, sticking with FD initially will be a wiser alternative.
Buying a life insurance policy is only a first step.
It is also essential to know how to use life insurance money wisely.
In this process of insuring ones family (specially for a bread earner), it is essential to maintain monthly budget and expense tracker.
These days, tracking expense is easy. Use a suitable mobile APP and start tracking all expenses.
Generate a report of expenses and show it occasionally to your family.
Let them know what type of bills, fees etc needs payment to run the house.
Now it is upto the family to pick as much clue from here while the main bread earner is around.
This will eventually help the family to use the life insurance corpus wisely.
Wise utilisation of insurance money means the following:
- Becoming debt free,
- Creating an emergency fund and,
- Investing money for monthly income generation.