Term Insurance
How much Term Insurance coverage do you need?
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6 min read | Updated on January 10, 2025, 10:41 IST
SUMMARY
Discover how to compute term insurance coverage with our step-by-step guide, and avoid common mistakes to secure your family's future.
Here, we will provide a step-by-step approach to computing your term insurance needs.
What is a term insurance coverage?
Term insurance coverage or ‘sum assured’ is the promised amount the insurance policy agrees to pay the nominee in case of the policyholder’s unfortunate death. This amount is determined when buying a term insurance policy, and depending on the insurance terms, it can be increased or reduced in the future.
What are the factors to consider while choosing coverage?
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Your income and responsibilities play a pivotal role in deciding the coverage amount. As per a general rule, you should opt for coverage of at least 10-15 times your annual income. Further, you should always consider higher coverage if you have significant financial responsibilities such as existing or future debts, ageing parents or plans for your children’s higher education.
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Your family structure and the number of dependents are also important factors to consider. For instance, if you are single, the coverage requirement shall be lower than if you are married to a non-working spouse. Considering each dependent’s financial requirements before finalising the coverage amount is important.
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Your existing debts and obligations also play a critical role in determining the appropriate coverage. In case you have a home, car or personal loan, you must opt for a higher coverage as your family would need to take care of the financial burden in your absence.
How do you calculate your coverage needs?
You can choose any of the following methods to calculate your coverage needs:
| Method | Description | Example |
|---|---|---|
| Income replacement method | Also known as the thumb rule for term insurance coverage, this method suggests that your coverage should be 10-15 times your annual income. | If your current yearly income is ₹10,00,000, your coverage should be between ₹1,00,00,000 and ₹1,50,00,000. |
| DIME method | DIME is an acronym for Debt, Income, Mortgage, and Education. You need to take care of all these four factors while evaluating the coverage needs. | If you have ₹5,00,000 in debts, an annual income of ₹10,00,000 with support for 10 years, a ₹30,00,000 mortgage, and expected education costs of ₹15,00,000, your coverage should be ₹1,50,00,000. |
| Standard of living method | You need to calculate the amount of money your family requires to maintain the current living standard and multiply the amount by the number of years you think they would require such support. | If your family needs ₹6,00,000 a year and you wish to provide for them for 15 years, aim for a policy offering ₹90,00,000 in coverage. |
| Human life value method | This method takes account of your current age, retirement age, and current annual income. Calculate the present value of your future earnings until retirement. | If you are 30, planning to retire at 60, and the current income is ₹12,00,000, you need to have ample cover that supports your family until you retire if you die today. The present value of ₹12 lakhs paid per year at a 6% discount rate shall be calculated by using the PV of Annuity Formula: PVA = P * (1-(1+r)^-n)/r The present value shall be approx. ₹1,65,17,800 at 6% discount rate. |
| Needs analysis method | You can combine the dependents' approximate financial requirements by listing future expenses such as children's higher education, spouse’s retirement, daily living expenses, and any outstanding debts. | If future needs and debts are ₹70,00,000 plus ₹40,00,000 for 20 years of daily expenses, your coverage can be ₹1,10,00,000. |
What are some common mistakes to avoid?
Contrary to popular belief, having a very high coverage (overinsuring) can result in high premiums that can jeopardise your finances. However, even worse could be underinsurance, which can leave your family vulnerable to financial strain in your absence. The best advice we provide is to use any of the methods suggested before and come up with a coverage amount that you feel will be enough to secure your family in the future.
Summing up
Term insurance can be an excellent tool for personal financial planning, provided you have a clear picture of your current and future requirements. You must consider different factors such as income, debts, and family needs to evaluate the appropriate amount. You can use any calculation method to arrive at the number.
However, it is also critical to regularly revisit your insurance needs to ensure they remain in sync with any life changes, providing peace of mind to you and your loved ones.
FAQs
What is the term insurance coverage?
Term insurance coverage, or 'sum assured', is the amount the insurance policy agrees to pay your nominee in the event of your untimely death.
How should I determine the amount of term insurance coverage I need?
You should consider your annual income, financial responsibilities, family structure, and existing debts to calculate the appropriate coverage amount, typically 10-15 times your annual income.
What are the methods used to calculate the need for term insurance coverage?
You can use the Income Replacement Method, DIME Method, Standard of Living Method, Human Life Value Method, or Needs Analysis Method to determine your ideal term insurance coverage based on your specific financial situation and obligations.
What are common mistakes to avoid when choosing term insurance coverage?
Avoid over insuring, which can lead to unsustainable premiums, and underinsuring, which may leave your family financially vulnerable; instead, aim for a balanced coverage that suits your financial circumstances and future needs.
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