How Much Life Insurance Do You Need?

How much is your life worth? Well, that’s one dreary question to ask. But when you step out to buy life insurance, you’d need to answer it.

For various life insurance products, deciding on an adequate life cover is the first and foremost objective so your family can remain financially secure when you’re not around. The cover should be big enough to sustain the rising inflation, settle all outstanding loans, generate a suitable income replacement for your family, and let them lead a comfortable life. For products that are a blend of insurance and investment, that give you back a regular payout or income post-retirement, you need to decide on how much to invest - so that the amount you receive on maturity is sufficient enough to fulfil your goals/objectives.

Now that you’ve understood the importance of buying adequate coverage, how do you calculate it? The internet gives you a lot of thumb rules to be followed, but they don’t factor in your specific needs and requirements. And the coverage amount also varies across different products.

In this article, we will guide you through it all. So come, let’s decode!

Cover Amount You Need Under Every Type Of Life Insurance Plan

Term Insurance Policy We will start with the simplest and cheapest form of life insurance. The main purpose of a term plan is to protect your dependents from financial instability in your absence. This financial instability is caused by the gap between the amount you leave behind and the amount your family actually needs. You can calculate this gap by subtracting the amount you owe from the amount you own.

How to calculate the amount you owe? By factoring in the following aspects -

How to calculate the amount you own? Factor in the existing funds you hold. This will include - the money you have, cash at the bank, and financial products you’ve invested in, like mutual funds, fixed deposits, etc.

However, these funds will not be readily available to be used and so you will have to multiply them by their respective risk factors. Risk factors include interest rates, commodity and stock prices, etc. - that keep fluctuating and changing the price of the financial instrument.

Risk factors to consider here -

• Existing life insurance plans @ 100%
• Savings, cash, fixed deposits @ 100%
• Equity investments @ 50%
• Gold and residential property @ 0% (You wouldn’t want these assets to be liquidated for grocery purchases or paying off loans/liabilities - so taking them at zero value)
• Stock options @ 0% (These are high-risk investments - so taking them at zero value.

Also, it’s very important to factor in an inflation rate of 6-8% while calculating the cover amount. This will ensure that the cover you buy today is sufficient for tomorrow. If you have invested in any other life insurance product, you can subtract that amount from the term cover amount you are planning to buy. This amount will be the gap you will need to fill through the term insurance plan.

Endowment Policy

It also gives you the dual benefit of insurance and investment. In exchange for the premiums you pay, Endowment Plans help you accumulate a good savings fund, while also providing a small life cover to take care of any eventualities. They are a great option if you have important financial goals, like - buying a house, starting a new business, etc. - lined up in the future, or if you are a salaried individual and want to ensure financial stability.

To calculate the cover amount -

• Figure out your financial goals and the money you and your family would require to fulfil them. For example, you think you will need Rs. 20 Lakhs to start a small business after 15 years. In this situation, you can buy an Endowment Plan with a cover amount of Rs. 20 Lakhs, for a period of 15 years.
• Consider aspects like any other insurance plan you own, your assets, liabilities, etc.
• Factor in inflation of 6 to 8% over this amount - for a period of at least 12-15 years.

If the endowment plan doesn’t allow you to select the cover amount - In some products, you are given the option of only choosing the premium amount, and the cover amount will be a multiple of the annual premium, i.e. the total investment you make. Therefore, before deciding on the amount to invest, assess your needs and goals of investing, and thoroughly read the brochure and policy wordings before finalising.

Money-Back Policy

Here, you invest money during a specific period of time, and then receive the “money back” in periodic payouts in the future, usually with a guaranteed return. Such plans cater to financial commitments that are spread over a span of time, like - making EMI payments or arranging for a fixed passive post-retirement income.

To calculate the cover amount -

• Define the financial goals you want the policy to help you achieve.
• Estimate the payouts you will require in the future to achieve those goals.
• While calculating the payout amount, take into account key milestones, like your EMIs for a vehicle, home loans, retirement, etc.
• Lastly, factor in an inflation rate of at least 6 to 8%.

If the money-back plan doesn’t allow you to select the cover amount - Under some products, you are given the option of choosing only the premium amount, and the cover amount will be a multiple of the annual premium (total investment) you pay. Therefore, just like endowment plans, assess your needs and goals of investing, and thoroughly read the brochure and policy wordings before finalising the plan.

Child Life Insurance Policy

One of the best ways to secure your child financially, both in your presence and absence, is by investing in a child insurance plan. It is a healthy blend of both insurance and investment, thereby, helping you to create a fund that’s sufficient to cover several important milestones in their life, like - their education, wedding, etc.

To calculate a sufficient cover amount under a Child Life Plan, you should -

• Note down the milestones you wish to cover, whether it’s higher studies, wedding expenses, etc.
• Estimate your existing life insurance covers, gold, cash, etc. And liabilities, like rents, loans, etc. This will help you understand how much you can actually spend.
• Analyse how much each milestone would cost you. Also, factor in an inflation rate of 6 to 8% for at least 12 to 15 years - since the milestones are planned for later stages.

Whole Life Insurance Policy

As the name implies, this policy covers you for your whole life. The basic goal here is to ensure lifelong financial protection for your loved ones. Given this is a guaranteed payout, Whole Life Insurance can be bought as an expression, a parting gift, or a legacy that you’d want to leave behind for your family.

To calculate the cover amount you’d need here, consider the following aspects -

• Your short-term expenses, like daily expenses, monthly bills, children’s school fees, etc.
• Your long-term goals, like children's higher studies, wedding expenses, etc.
• Your loans and liabilities.
• Your assets, like cash at the bank, savings, fixed deposits, investments, etc.
• Any existing life covers you own, etc.

The amount you choose should be adequate to support your family financially and to leave behind a legacy for your children. Also, remember to factor in an inflation rate of 6-8% over this amount - to make it sufficient for the future.

Unit Linked Insurance Plan (ULIP)

It is an investment product that offers you a variety of fund options to invest in, depending on your risk appetite, to achieve your financial goals. Along with the investment, it also provides you with a fixed amount of life cover.

Unlike other life insurance policies that pay a predefined amount on policy maturity, ULIPs don’t pay a fixed amount on maturity - the amount payable will be market-linked. Under a ULIP, the cover amount is usually 10 times the premium you pay every year. Depending on the product, it can also be 15-20 times the premium. So, you should make sure the amount you invest in a ULIP -

• Fits your current budget.
• Gives you enough returns for the long-term goals you want to achieve.

Annuity Plan

It is essentially a type of retirement plan. An annuity is simply a chain of periodic payments that are made to you at specific intervals post-retirement. Based on the annuity rate determined by the insurer and the funds accumulated under your annuity plan, your payouts are determined. This means the more you invest while you’re earning, the greater income you will receive on a regular basis after you retire.

Annuity Plans make sure you don’t outlive your money and enjoy the simplicity of regular payments - even when you don’t earn any more.

Please note: There is no ‘sum assured’ or ‘cover amount’ in an Annuity Plan. Depending on the money you invest, you receive periodic payments post-retirement. So before buying an Annuity Plan, determine how much annuity (income) you want to receive throughout your retirement years. And accordingly, make the premium payments.

Pension Accumulation Plan

This plan helps you invest your savings in a systematic manner to accumulate a retirement fund.

How much to invest in a Pension Accumulation Plan?

• Make sure the amount you receive is enough for your post-retirement needs - so you can lead a comfortable and financially sound life without depending on anyone.
• Estimate the amount of money you will need after you retire, and accordingly decide the amount you must invest.
• Don’t forget to factor in an inflation rate of around 6 to 8%.

Important note -

When your pension accumulation plan matures, you must use the accumulated retirement fund in accordance with IRDAI guidelines. So once you get the maturity benefit, you have three options -

• Withdraw 60% of the accumulated fund (also known as ‘commutation’ in technical terms) and invest the remaining amount in a single-premium annuity plan.
• Invest 100% of the corpus net of withdrawals, if any, in a single-premium annuity plan offered by the same insurer.
• Invest 50% of the corpus net of withdrawals, if any, with the same insurer and the remaining 50% in a single-premium annuity plan offered by another insurer.

Remember these conditions before investing in a Pension Accumulation Plan - to experience a smooth process.

Wrapping up!

Life insurance is not about putting a value on your life. After all, life is priceless. But to make sure you and your family can live a financially stable life, you need to opt for an adequate cover amount, while buying a policy. Because having an inadequate cover is equal to having no cover at all. We hope this article guides you through the entire journey and makes it a good experience for you.