Life can be unpredictable, and we never know what’s around the corner. That’s why having a term life insurance plan is so important – it’s all about making sure your family is well taken care of if the unfortunate happens. But, hold on! Here’s the big question: What’s the right amount of term insurance cover?
Did you know too little term insurance can be just as dangerous as none at all? You need to ensure your family can keep their lifestyle, cover daily expenses, pay off any debts, and have peace of mind during an already tough time. Adequate coverage means they won’t be left struggling to make ends meet, even if you’re not around to support them.
Let’s take the case of Rohan, who lives in Pune with his family. Rohan’s spouse is a homemaker, his children are in high school. Rohan earns Rs 12,00,000 annually and decides to purchase a term insurance plan with a Rs 50 lakh sum assured, without fully understanding his family’s financial needs. Unfortunately, Rohan passes away unexpectedly, leaving behind a home loan of Rs 45 lakh.
So, will the Rs 50 lakh cover amount be sufficient for his family, given that they are all financially dependent?
In Rohan’s case, the Rs.50 lakh cover is quickly eaten up by the home loan, leaving only Rs 5 lakh for daily expenses, school fees, and other essential costs. So, his family had to make difficult choices and sacrifices, impacting their quality of life and limiting their aspirations, such as higher education or family events.
What’s the takeaway?
Every family’s financial situation is unique, and relying on general rules of thumb often isn’t enough. It’s essential to take a personalized approach, considering your specific lifestyle, income, needs, and future requirements, to determine the right amount of term insurance cover.
How Much Term Insurance Do I Need?
A common guideline is to choose coverage that’s 20 times your annual income. For example, if you earn ₹10 lakh a year, a ₹2 crore policy would provide a sufficient financial cushion. This ensures your family can maintain their lifestyle, cover expenses, and meet future goals in your absence. While this thumb rule is useful, it’s important to adjust it based on your unique situation to ensure your family’s needs are fully met.
The very purpose of term insurance is to shield your family members who depend on your income from any financial setbacks that may arise when you’re no longer around. The financial gap, which term insurance aims to fill, results from the difference between what you leave behind and what your family requires. To calculate this gap effectively, it’s essential to figure out your obligations and your holdings
1️⃣What Are Your Financial Obligations?
This refers to the financial burden that falls on your loved ones when you, the primary breadwinner, were to pass away during the policy duration. It includes both immediate daily expenses and future financial needs.
Let’s break it down –
- Keeping the Lights On: Daily Living Expenses
First things first, your family needs to keep the lights on and food on the table. This fund is crucial to building a safety net that generates steady passive income to cover your family’s day-to-day necessities. You can figure it out by adding up monthly and yearly costs like:
- School fees
- Househelp wages
- Rent or mortgage
- Utility bills
- Groceries
Once you have that total, divide it by an estimated interest rate that you’d get from fixed deposits after taxes. This gives you a ballpark figure of how much is needed to keep the household running smoothly.
- Dream Big: Future Aspirations
Next, the dreams and aspirations that you and your family hold in your heart. This includes significant one-time expenses in the future, such as:
- Your spouse’s further education
- Your child’s higher education
- Wedding costs
- Facing The Inevitable: Major Liabilities
Finally, we have the not-so-fun part: debts and loans. You should take stock of any loans or debts you have, as these will become your family’s responsibility if something unfortunate happens to you. This includes:
- Home loans
- Personal loans
- Vehicle loans
- Joint loans
- Any other liabilities
2️⃣What Are Your Holdings?
Alright, now let’s talk about what you actually own. You can simply add up all your assets and money to get your total worth. Right?
No, it’s not that simple. Your assets aren’t all easily converted into cash, and they each carry different levels of risk. To get a more accurate picture, you need to consider these factors by multiplying each asset by its risk factor.
Here’s how you should do it:
- Existing Life Insurance Covers @ 100%
These are straightforward and reliable, so you can count them fully.
- Savings, FDs & Cash @ 100%
These are liquid and readily available.
- Equity Investments @ 50%
Consider your equity shares and investments linked to the stock market at only half their total value. Stocks can be unpredictable, so it’s safer to count just half.
- Gold & Residential Property @ 0%
Considering practicality, it’s best not to rely on assets like gold and residential property for immediate expenses such as grocery purchases. So, take them at zero value.
- Stock Options @ 0%
Since these investments are risky, think of them as having no initial value. If they perform well, that’s an added bonus.
Adding up these calculations will give you the total amount you own.
Bringing It All Together
So, the total cover you will need = Your Obligations – Your Holdings
Psst…Keep Inflation in Mind!
Prices can increase over time, so it’s important to consider the increasing cover option available under term life insurance policies. This option systematically raises your coverage as the years go by, helping you stay ahead of inflation and ensuring your family’s financial security remains strong.
Alternatively, to account for inflation throughout the entire term, you can also consider multiplying your cover amount by 2.5 to 3X. This ensures an inflation-proof cover that meets your family’s future needs.
By taking these steps, you can rest easy knowing that your family will be financially secure, come what may.
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