How to Calculate the Correct Term Insurance Coverage

Term life insurance is a crucial financial tool that provides security and peace of mind for your loved ones in the event of your untimely death. It ensures that your family has the necessary financial resources to cover their expenses and maintain their standard of living. However, determining the right amount of coverage can be a daunting task. In this article, we will guide you through the process of calculating the correct term insurance coverage and highlight the factors you need to consider.

Understanding Term Life Insurance

Before delving into the calculation process, let’s take a moment to understand what term life insurance is and how it works. Term insurance is a pure life cover, meaning it provides coverage for a specified period without any maturity benefit. You pay an annual premium to the insurer for a predetermined number of years, and in return, the insurer promises to pay a sum assured to your family if you pass away during the policy term. Term life insurance generally offers higher coverage for a lower premium compared to other types of life insurance policies.

Step 1: Factor in Your Dependent’s Monthly Expenses

The first step in calculating the appropriate term insurance coverage is to consider your dependent’s monthly expenses. Determine the total amount required to cover their essential needs, including utility bills, food, education expenses, healthcare costs, and any other necessary expenditures. It is generally recommended to provide coverage at 10-15 times the annual expenses. However, it is essential to assess your specific circumstances and make an informed decision.

Let’s illustrate this step with an example. Meet Akshay, a 35-year-old working professional with a wife, parents, and two children aged 7 and 3 years. Their monthly expenses amount to Rs 60,000, totaling Rs 7.2 lakh per year. Considering the rising inflation, increasing education costs, and healthcare expenses for his parents, a multiple of 15 times the annual expenses is suggested. Therefore, Akshay’s coverage based on future household expenses would be Rs 1.08 crore.

Future household expenses: Rs 1.08 crore

Step 2: Evaluate Your Liabilities

The next crucial aspect to consider is your outstanding liabilities. Assess your financial obligations such as home loans, car loans, personal loans, credit card debts, and any other significant debts you may have. The objective is to ensure that your term insurance coverage is sufficient to settle these liabilities if something were to happen to you.

Let’s continue with Akshay’s example. He has an outstanding home loan of Rs 70 lakh. It is crucial to include this liability when calculating the appropriate term insurance coverage.

Outstanding home loan amount: Rs 70 lakh

Step 3: Assess Important Life Events and Goals

In this step, you need to identify any significant life events or goals that you want to secure financially through your term insurance coverage. For instance, if you have young children, you might want to consider their education and marriage expenses. It is wise to add these amounts to your coverage requirements to ensure that your family’s future goals are not compromised in your absence.

Akshay has two young children, and he has already started saving for their higher education. He contributes Rs 7,000 per month to create a corpus of Rs 20 lakh over the next 15 years. If Akshay were to pass away prematurely, these goals would be at risk. Hence, it is crucial to incorporate this amount into his term insurance coverage requirements.

Step 4: Consider a Retirement Corpus for Your Spouse

In addition to covering your immediate expenses and liabilities, it is essential to consider the long-term financial security of your spouse. Evaluate the amount your spouse would require for a comfortable retirement and factor it into your term insurance coverage calculation.

Akshay estimates that his wife would need at least Rs 80 lakh in her retirement corpus. This amount should be included in his term insurance coverage to ensure that his wife can maintain a good quality of life post-retirement.

Retirement corpus for spouse: Rs 80 lakh

Pro-tip: Be Conservative in Your Estimates

When calculating your term insurance coverage, it is essential to be conservative in your estimates. Since it involves predicting into the future and making assumptions, it is always better to err on the side of caution. Even if you think your family can manage with a lower monthly expense amount, it is recommended to estimate a slightly higher figure to provide a buffer for unexpected circumstances.

Step 5: Factor in Your Existing Wealth

While calculating your term insurance coverage, it is crucial to consider any existing wealth or investments that can be accessed by your family in the event of your demise. These assets include your provident fund, fixed deposits, mutual funds, real estate, and other investments. Deducting the value of these assets from your coverage requirements ensures that you do not overestimate the amount needed.

Let’s assume Akshay has a mutual fund portfolio valued at Rs 30 lakh. This money is readily accessible to his family upon his demise, and therefore, it can be deducted from his term insurance coverage requirements.

Considering all the factors discussed, let’s calculate the total term insurance cover Akshay needs.

Total Term Insurance Cover Akshay Needs

According to the calculation, Akshay would require a term life insurance cover of Rs 2.48 crore to adequately protect his family’s financial future.

Pro-tip: Consider Your Age and Current Wealth

When determining your term insurance requirement, factors such as age and current wealth also play a significant role. Young individuals in their 20s who are not married may not require a high coverage amount. On the other hand, individuals in their 50s with a substantial investment portfolio and financially independent children may not need a substantial term insurance coverage. It is crucial to reassess your coverage needs periodically, especially when significant life events occur.

Bottomline

Calculating the appropriate term insurance coverage is not an exact science, but it helps you understand your future financial priorities and evaluate your current standings in providing financial stability to your family. Remember to consider your family’s monthly expenses, liabilities, important life events, retirement corpus, and existing wealth when determining the coverage amount. It is always recommended to be conservative in your estimates and reassess your coverage needs periodically. Take advantage of digital platforms like the ETMONEY app to explore and purchase the best term life insurance plans in a hassle-free and paperless manner.

Now that you have a better understanding of how to calculate the correct term insurance coverage, you can ensure that your loved ones are adequately protected in the face of any unforeseen circumstances. Take the necessary steps today to secure your family’s financial future.

Additional Information:

• It is crucial to review your term insurance coverage periodically, especially when significant life events occur, such as marriage, the birth of a child, or a change in financial circumstances.
• Consult with a financial advisor or insurance expert to understand the nuances of term life insurance and determine the right coverage amount for your specific situation.
• Term insurance premiums are generally lower for younger individuals, so it is recommended to start early and lock in a lower premium rate.
• Opt for a policy term that aligns with your specific needs. For example, if you have young children, consider a policy that provides coverage until they become financially independent.
• Consider the inflation rate while calculating your coverage amount to ensure that your family’s future expenses are adequately covered.
• Keep all relevant documents, such as policy papers and nominee details, easily accessible to your family members in case of an unfortunate event.