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Your best friend just got the latest iteration of Fitbit fitness tracker, does that mean you should get one as well? Unless you are a fitness freak or you would utilize the product to the maximum, there is no point in blindly buying it because your best friend got the same. The same rule applies to term insurance as well. Your colleague at the office got a life cover of Rs. 75 lacs, should you opt for the exact same life cover? If the sum assured is greater than your needs, it is still fine. But what if the life cover falls short for you, while it suffices for your colleague?
To avoid such scenarios, one should know the sum assured that would hold good for them. Insurance agents usually sell us endowment plans when you want to go for an insurance. Though there is no harm in that, you can get much higher life cover using a term insurance for the same amount. For example, a yearly premium of Rs. 16000 would give life cover of about Rs. 6 to 7 lakhs if you opt for endowment plans. Term plan, on the other hand, would give you anywhere about Rs. 70 lakhs for the same premium amount.
Term insurance plans come with lots of inbuilt benefits. But those are for a different discussion thread. There are some simple ways of calculating how much term insurance you would need, let us focus on those for now. It is a series of calculations, which completely depends on your lifestyle and expenditures.
One usually opts for term insurance to make sure the lifestyle of their loved ones is not impacted in any way whatsoever. So, add up all the expenses that you undergo monthly and multiply them with 12 to get a yearly count. Some of the main expenses you need to cater for:
These are the bare minimum expenses that need to be taken care of in your absence. You need to extrapolate these over a year and factor in inflation. Let us assume you are 40 and your yearly basic expenses sum up to Rs. 400000 per year and inflation rate remain at 6% p.a., the same expenses would swell up to roughly Rs. 1300000 a year. To keep things simple, one can consider an average amount of Rs. 700000 per annum as expenses.So, you would need 700000 * 20 (number of years till you retire) = Rs. 1.4 Crores.
A house is one of the largest purchases that one can make in a lifetime and lot of us take home loans for the same. If we assume you have a home loan EMI of Rs. 25000/month and you would need 10 years to clear that up, it would add up to 25000 * 12 * 10 = Rs. 3000000.
If you have any disposable assets such as investments in the capital market, gold, fixed deposits etc. you can deduct the same from your liabilities. Again, assuming a value of Rs. 800000 as your total assets, the pending amount is:
Rs. 3000000 – Rs. 800000 = Rs. 2200000
One must keep in mind that these are speculative numbers and just for calculations.
You can include potential expenses of important milestones in your life under this category. For an instance, you can set aside some money for your kids’ education or even marriage under this category. If you do not have any such responsibilities at this point, you can skip it altogether. But let us just consider an amount of Rs. 1500000 for children education for the sake of calculations.
To arrive at required sum assured we need to add all these pieces together.
Required Sum Assured = Rs. 1.4 Crore + Rs. 2200000 + Rs. 1500000 = Rs. 1.77 Crore.
You need to keep reviewing the sum assured requirement periodically and revise them accordingly. Alternatively, you can use human life value calculator and other methods of calculation to arrive at the sum assured.
Most of the insurance companies and web aggregators provide HLV or Human Life Value calculators online to help you figure out how much term insurance cover you need. This calculator works on a simple formula of time value for money. Basically, it’s a present value of all the future income that you are expecting to earn in rest of the years till you retire. These easy to use calculators are available on the websites of insurance providers and require certain information from your end. Basic information that you need to provide are your current age, current annual income and expected future rate of return.
Another efficient method that you can use for deducing the insurance cover you need is income multiplier method. Using this technique, you need to multiply your income by a factor based on the age group you belong to. You can arrive at a minimum and maximum insurance cover that would suffice for your age and income. While using the income multiplier, one needs to deduce their expenses from their net income and then use the multiplying factors. For people in 20-30 years bracket, multiply your income by a factor of 5 for minimum insurance value and 10 for maximum insurance value. For other age groups refer to the following table.
|First Name||Last Name||Username|
|Age Group||Minimum Multiple||@Maximum Multiple|
For the person in this example, a life cover of Rs. 1.77 Crore would be sufficient. Calculation of term insurance is not a one-time activity and one must revise them once every five years. So that any changes are well accounted for. You can use a similar approach to figure out how much term insurance would be enough for you.
A recent research done shows that in India about 80% of the urban Indians either have very low insurance coverage or no insurance coverage at all!
Thus, you can choose to be a part of the remaining 20% by opting for an adequate insurance coverage for yourself. You can use any of the above-mentioned methods to determine your insurance need. However, a simple thumb rule is 10-12 times your annual income, irrespective of your age. So, if you are earning Rs 10 lakhs a year, your minimum insurance coverage should be Rs 1CR to Rs 1.2 CR to stay adequately insured.