Have you looked at the insurance aggregator's website and wondered how much insurance cover you should take? At the preliminary view, an insurance cover of INR 50 lakhs for someone who just started working also looks very good and an insurance cover of INR 1 crore may not be enough for someone who is married with 1 child. The amount of cover varies from person to person based on their financial background, situations, responsibilities, lifestyle etc.
You can read our Article on 10 things to note before buying term insurance which will give you an exact idea of what is term insurance and all the things that you must focus on before investing in one.
We have listed below the process to compute your term insurance cover.
Step 1 - Use your actual Income
You are opting for term insurance to ensure that the financial life of your loved ones is not impacted. Based on this, your term insurance cover must compensate for the income/earnings that you were providing to your family.
Your monthly income is the minimum amount that your financial dependents must get from the term insurance cover.
Accordingly, where your income is INR 1 lakh per month, your annual income would be 12 lakhs. Your insurance cover amount must be such that on investing it in a debt product of around 9% return, you get the annual income value as returns.
Income - 1 lakh per month
Annual income - 12 lakhs
Return % - 9%
Amount of cover - (12 lakhs*100)/9 = 1.33 crores
On an investment of INR 1.33 crores in a debt financial product which gives a return of almost 9% per annum, a return of INR 1 lakh per month (i.e. 12 lakhs per annum) will be received.
1.33 crores X 9% pa = 12 lakh per annum i.e. 1 lakh per month.
Post taxes of around 20% that would be INR 80,000 per month which shall be equal to the in-hand salary of the person with the monthly income of INR 1 lakh.
- You can also do a reverse calculation, where you may take the in-hand salary of say INR 1 lakh (this would be a post-tax number)
- Accordingly, the pre-tax would be INR 1.25 lakhs
- You have to earn INR 1.25 lakh for 12 months i.e. INR 15 lakhs.
- The cover amount must be such that it gives 15 lakhs as 9% of the cover amount.
- Using the above formula = (15 lakhs*100)/9 will give you 1.66 crores.
Hence, you should take an insurance cover of INR 1.66 crores.
Step 2 – Loans and other liabilities.
You should add the value of your total loans and other debts due to your insurance cover. This will ensure that there is no fallout of debt on your dependents.
In this case, if you already have home loan insurance, verify if it is sufficient to cover the entire outstanding loan. If yes, then you need not add that amount to your term insurance cover, if not then add the loan amount to your insurance cover.
If there are any other loans or liabilities that you have taken from anyone, add that amount to your term insurance cover amount. For example, a car loan or a personal loan.
Step 3 – Reduce your assets
Where you have any investments made in the form of mutual funds or any other investments for your retirement, reduce the value of the same from your insurance cover amount.
In this case, please keep in mind that the value of the assets like the house you are residing in or depreciating assets like your car should not be considered. These are the assets that are used by your family/people.
Step 4 – Important Events
This includes setting aside a lump sum amount for important events or milestones of life such as education of your child, or their marriage or a business set-up for your partner. Calculate roughly how much you would need for your such events (Do include inflation into consideration).
For example, if you feel that today when your child is 5 years old, you would need INR 20 Lakhs for their education 15 years from now. Ensure that this INR 20 Lakhs is not based on the education cost today, but an estimated cost of the same 15 years from today.
(Your annual income*100)/ return rate of a debt product + outstanding liabilities - Investments (saleable assets) + Inflated cost of important futuristic life events
Many insurance aggregators and their website calculate the term insurance cover that may be applicable to you. These calculators work on a simple formula of the time value of money. Basically, it’s the present value of all the future income that you are expecting to earn until you retire. These easy to use calculators are available on the websites of all insurance providers and require certain information from your end like your current age, current annual income and expected future rate of return.
These calculations may not fulfill your entire insurance needs specific to your requirements. You must use an adequate method otherwise even after obtaining term insurance your family/dependents will not be free of their financial liabilities.
The best way to buy term insurance is to directly obtain the same from the website of the insurance provider. Refer to our Article http://www.wealthcafe.in/myths-about-buying-insurance-online/
To learn more - you can check our course - NM 102: Build a Safety Net. Use code SAVE20 for 20% off.