How Much Term Insurance Do I Need?

People’s needs differ depending on various factors. For instance, when you are a family of just two, a one BHK house would suit your needs. When you have children, you will need a bigger house for a comfortable living.

The same applies to your term insurance coverage. The needs differ for each person. Figuring out the right cover amount to accommodate your family’s financial goals becomes crucial, so they aren’t left hanging if you aren’t around anymore. The article below aims at making the calculation easier for you. Let us head right into it!

How much Term Insurance Cover Amount should you Buy?

A term insurance policy protects your dependent family members from financial jeopardy by paying them the sum assured, i.e., a fixed amount of money, if you pass away during the policy term. This amount will help them meet their financial goals, take care of financial liabilities, and continue living a comfortable lifestyle.

The level of financial instability they might face in the future depends on what you leave behind for them versus what they actually need. This financial gap can play havoc in their lives, which is why a term insurance policy becomes a significant purchase.

How do you Calculate the Financial Gap?

To calculate the financial gap, compare the finances you possess against your financial goals and obligations. In simpler words, it is the difference between the amount you own and the amount you owe.

Your term insurance cover should be sufficient enough to bridge this gap. It will act as a shield for your family’s future financial security.

Let’s analyse this in detail.

The Amount you Owe.

The amount that you owe includes both short and long-term expenses that you should meet for a stable lifestyle. If you are your family’s breadwinner, your loss can put the burden of these expenses on your family.

The amount that you owe includes:

1️⃣ Living Expenses Fund

Living expenses fund is the amount that is required to meet the regular expenses of your family. This includes everyday necessities like house rent, maintenance fees, groceries, school fees, van fees, domestic worker salaries, and other household expenses. Sum up all these expenses for one year and divide it by the expected rate of interest.

Note: You can take 3% as interest rate as it is the current ROI of fixed deposits after deducting taxes.

2️⃣ Major Expenses Fund

These are primarily one-time expenses that might be incurred in the long run. Some of them include your plans of hosting a gala-wedding for your child, gifting a foreign trip to your spouse, or sending your child abroad for higher education.

3️⃣Major Liabilities fund

All the debts and loans that you owe come under this fund. This may be a housing, car, joint, or personal loan, etc. If you aren’t around anymore, your family will have to face the brunt of repaying these loans. Calculate the total of all such outstanding dues.

Now, let’s move on to the amount that you possess.

Calculating the amount you own

While calculating the amount you own, factor in your savings and assets.

However, keep in mind that not all that you own will be readily available to be used for your family’s everyday needs. You should look deeper into their associated liquidity risk factors.

Let us look at some of the examples of calculating the liquidity of your assets:

👉If you have existing life insurance policies or FDs, they can be taken as 100% liquid assets. The same applies to savings, cash in hand, etc.

👉Stock options can be calculated at 0% as they are associated with high-risk factors. Fortunately, if any of them pay off, you can consider them your bonuses!

👉Gold and properties can be taken at 0%. Why, you ask? It would be bizarre to liquidate these big assets for buying everyday groceries! So consider them off your liquid asset list.

👉Equity investments can be calculated at 50% risk. It is recommended that you take your equity-related investments at half their total value.

Once you’re done calculating all this, you can arrive at the cover you need to buy by using this formula -

Formula

Before finalising this, should you consider future inflation?

Yes. Inflation is something that we have no control over. So, the cover amount that might be enough right now, will not hold the same value in some years because of the time value of money.

To avoid such a situation and effectively tackle inflation -

a. You can opt for the increasing cover option with your term insurance plan. With this, your cover amount will increase periodically by a certain percentage till it hits a maximum limit as specified under the policy. This increasing cover amount will serve two purposes - it will beat inflation and accommodate your growing needs.

b. If you wish to opt for an inflation-proof cover right now, you can multiply the cover amount by 2.5-3x.

To Conclude,

That’s pretty much everything you need to know about how to calculate the right term insurance cover amount. We hope that you take the time to carefully assess your needs and requirements to make the right decision that will financially secure your family. You can also make use of the ABSLI Human Life Value Calculator to help you get an estimate of the term insurance coverage that will be appropriate for your family. It is available at no cost and helps in speedy accurate computations.