How Much Term Insurance Do I Need?

by SMCIB on Monday, 22 April 2024

How Much Term Insurance Do I Need?

Imagine your family's financial security as a puzzle, where each piece represents a vital aspect of their well-being. Term insurance acts as the sturdy frame of this puzzle, offering a solid foundation to safeguard your family's future. It's like having a financial cushion in place to ensure their financial needs are met, especially if something unexpected happens to you. It's a straightforward product designed to provide pure risk coverage, meaning it kicks in to support your family if you pass away during the policy period.

Just as completing a puzzle requires careful placement of each piece, determining the right amount of term insurance involves piecing together various financial elements. This ensures that your family can navigate life's challenges without worrying about financial hardships.

You may ask - “How much term insurance do I need?”

Let’s get the answer to this question.

How Much Term Insurance Do You Need?

Buying insufficient insurance can be just as risky as having no coverage at all.

Let's consider an example involving Rahul, who lives in Bangalore with his family. Rahul's spouse is a homemaker, his children are in middle school, and his parents require regular medical checkups. Rahul earns Rs 20,00,000 annually and decides to purchase a best term insurance plan with Rs 1 Crore sum assured, without fully understanding his family's financial needs.

Unfortunately, Rahul passes away unexpectedly, leaving behind a home loan of Rs 1 crore.

And, here’s the important question - Will the 1 crore cover amount be sufficient for his family, given that they are all financially dependent?

In Rahul’s case, the 1 crore cover is quickly eaten up by the home loan, leaving little for daily expenses, school fees, medical bills, and other essential costs. This situation forces his family to make difficult choices and sacrifices, impacting their quality of life and limiting their aspirations, such as higher education abroad or grand weddings.

The lesson here is clear: every family's financial situation is unique, and a one-size-fits-all approach like thumb rules often falls short. It's crucial to take a systematic approach, considering your lifestyle, income, needs, and requirements, to accurately determine the cover amount.

So, how much term insurance do I need?

When you purchase term insurance, the primary aim 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, follow these steps:

  • Calculate the amount you owe
  • Calculate the amount you own

The Amount You Owe

It refers to the financial responsibility that falls on your loved ones when you, the primary breadwinner, are no longer there. It covers both immediate daily expenses and future financial needs.

Let’s break it down into categories for easier understanding -

  • Living Expenses
    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, and more. Then, divide this total by an estimated interest rate - similar to what you'd get from fixed deposits after taxes.
  • Big Dreams
    This fund covers significant one-time expenses in the future, such as your spouse's further education, your child's higher education, wedding costs, and similar major financial milestones.
  • Major Liabilities
    You should take stock of any loans or debts you have, as these will become your family's responsibility if something happens to you. Add up all your loans, including home loans, personal loans, vehicle loans, joint loans, and any other liabilities.

Summing all these three categories gives you the total amount you owe.

The Amount You Own

It's easy to think that you can add up all your assets and money to get your total worth. But the truth is, 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 with its risk factor. Here's how you should do it -

  • Existing Life Insurance Covers @ 100%
  • Savings, FDs & Cash @ 100%
  • Equity investments @ 50% - Consider your equity shares and investments linked to the stock market at only half their total value.
  • 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 do well, that's an added bonus.

Adding up these calculations will give you the total amount you own.

So, the total cover you will need = Amount you owe – Amount you own

Don’t forget about inflation!

It's important to remember that prices can increase over time. That's why you should 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.

Wrapping Up!

Choosing the right amount for your term insurance cover is absolutely crucial to safeguarding your loved ones' financial security. So, when asking yourself, "how much term insurance do I need?" remember to consider both the present and the future needs of your family. This means ensuring the cover is enough not just for immediate expenses like debts and living costs but also for long-term goals such as education, marriage, etc. By getting this balance right, you're not just providing financial protection - you're offering peace of mind and ensuring your family's well-being even in your absence.

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