Financial planning for an young individual earning ₹5 lakh per year

Take out accident insurance

At a young age, the probability of death from illness is lower than that caused by an accident. One should purchase an individual accident insurance policy, which is a low cost insurance solution for those who cannot afford a life insurance premium early in their careers. You need to take out accident insurance equal to at least 12 times your annual income, or 60 lakhs, which will cost you around Rs. 9,000 / – per year. It covers death as well as physical disability caused by any accident.

Buy health insurance

With the increasing costs of medical treatments, it is very important to have adequate health insurance. Purchase health insurance even if your current employer offers it, as there may be times when you change jobs the new employer will not provide it. If you purchase health insurance at this time, it may not cover any pre-existing conditions for the next three to four years. The amount of health insurance you need depends on the city you live in and your social status. Medical treatment in metropolitan cities is more expensive than in smaller towns, so the amount of health insurance coverage you need to purchase will depend. If the employer also covers your parents in the office policy, reserve this policy for your parents as it covers pre-existing illnesses from day one. You need to take out a health insurance policy of at least Rs. 5 lakhs which will cost you around Rs. 7,500 / – per year. Buy a separate policy for your parents also for an adequate amount.

Buy life insurance

In case your parents are dependent on your income, you must take out life insurance for a minimum amount equal to 15 times your annual income or Rs. 75 lakhs. As a general rule, you should purchase life insurance equal to 10 to 12 times the annual income. However, as your income will increase in the future, insurance premiums also increase with age. It is therefore prudent to block the premium for the remainder of the term by taking a higher cover. You must take out life insurance for seniority up to your retirement age, that is, cover for 35 years.

You should also purchase life insurance to cover any liability related to the mortgage loan to ensure that your legal heirs inherit the house and not the mortgage loan. For all life insurance needs, always purchase term-only insurance. Since you are tech-savvy, you should buy a term plan online which is cheaper than regular term plans. Please review your insurance needs periodically after your marriage, childbirth and increasing your income.

Create a contingency fund

You need to have an equal contingency fund to cover expenses in case you lose your job for at least six months. Since the contingency fund is supposed to be easily accessible and returns should not be volatile, you should invest this contingency fund in a system of liquid funds or a fixed deposit with a bank. In addition, I would advise you to get a credit card which gives you some financial flexibility. The credit card is a double-edged sword and should be used sparingly. Careless use of credit card can get you into debt trap. It should only be used in an emergency and not to pay for your daily expenses. The credit card can be added to the contingency fund.

Planning the down payment for the purchase of a house

Since you can get a home loan up to 90% of the value of the house if the loan amount does not exceed Rs. 30 lakhs, you can buy a house which costs around 30-33 lakhs with a margin of 3 lakhs. I assumed you would buy a house after five years. Since the time horizon for accumulating margin money is 5 years, you should invest in an aggressive hybrid fund through the systematic investment plan (SIP). To accumulate Rs. 3 lakhs over the next five years, you need to invest Rs. 3,650 / – every month assuming a conservative average annual return of 12%.

Planning wedding expenses

It is assumed that you will have to accumulate Rs. 10 lakhs after 7 years for your marriage. As the period available is reasonably long, you should invest in the Nifty or Sensex Index fund. To accumulate Rs. 10 lakhs in 7 years, you need to invest Rs. 7,650 / – via SIP assuming an average annual return of 12% per annum.

Retirement planning

Since you are currently unmarried and therefore cannot have child rearing and marriage goals at this time. But whether or not you are married or have children or not, like taxes, retirement is also almost a certainty, so you should consider retirement planning a vital goal. Rationally and logically, you should start saving for your retirement from your first salary. With the surplus of Rs. 6,850 / – left each month on your salary an amount of Rs. 10 crore can be accumulated in 35 years by investing in mid-cap funds. These funds, although volatile in the short term, can give you a return of 15% (net of tax) for such a long period. You can invest in an equity linked savings plan commonly known as ELSS if you have a tax liability and use it towards your retirement goal. I did not take into account the retirement benefits to be received at the time of retirement in this calculation.

Please review your goals and investments periodically and realign as necessary to achieve various financial goals.

Balwant Jain is a tax and investment expert and can be reached on jainbalwant @ gmail and @jainbalwant on Twitter.