How much cover should  I take in a term plan?

It is impossible to put a price tag on the value of life. Your life, the way you work hard for those you love, your hopes and dreams, everything that makes you 'you’—priceless! Getting your life insured is a matter of financial sense. While nothing can replace you, the purpose of life insurance is to ensure that your loved ones have enough money to take care of their needs, even in your absence.

First things first, it is essential to understand what a term insurance policy is.

A term insurance policy is a straightforward pure protection insurance product. With any term insurance plan, you pay an annual premium to the insurance service provider for a fixed term that typically spans decades. In exchange, the insurer becomes contractually bound to pay the fixed sum assured to your family members in case of your untimely death during the fixed term.

A term insurance plan does not offer frills and facilities such as a maturity benefit or money-back at intervals. The primary purpose of a pure protection term plan is to give you substantially high coverage for a lesser premium when compared to other life insurance products.

Insure for the Future

The next question is how much life insurance cover do you need—how much term insurance coverage is enough? A popular figure that gets thrown around is a Rs. 1 crore term plan cover. While there is nothing wrong with the number itself as it is a significant one, most people go with the flow without customising the solution to their specific needs.

The amount of term plan coverage you need may be driven by your current income, but it has much more to do with the future value of your family's goals. Here's a lowdown on how to calculate an adequate term insurance plan cover and what you need to factor in while deciding.

HLV Method

HLV or Human Life Value method focuses on understanding the economic value of a person's existence to the family. This human life value (HLV) calculates the amount of term plan cover you need based on your income, the value of future income, expenses, liabilities, expected future liabilities, financial goals, and investments. The HLV method takes inflation into account to help you decide how much coverage will be enough to meet the future goals you have set up for your family.

HLV = (Annual income x Years to retirement) + Loans - Savings

There are many free online HLV calculators to calculate how much money you need to meet your present lifestyle needs, the current rupee value of this corpus, and how much the amount would change when inflation and the future value of your lifestyle management are accounted for.

Expense Replacement Method

The preferred method for financial planners is the expense replacement technique, which requires you first to calculate how much your need to pay for current and future expenses (household needs, loans, educational liabilities, provision for dependent parents). By the end of this first step, you now know how much money your family needs.

The second step is to subtract the current value of your existing life cover and your other investments from this number.

Term plan cover = Family Expenses – Current value of life cover and investments

Neither the car your family uses daily, nor your primary residence can be added to the assets column as your family members are likely to continue using these assets.  The final amount you arrive at after subtracting any existing term plan cover and such investments from your overall expenses and goals figure is the amount of term insurance policy cover you require.

Income Replacement Method

As the name suggests, the income replacement method focuses on determining the term plan cover you require to replace the lost income of the family's breadwinner. Calculating your term insurance policy coverage is easy enough—calculate your current annual income and multiply that amount with the years you have left till retirement.

Term insurance plan cover = (Present annual income) x (Years to retirement)

For instance, if you are a 30-year-old professional with an annual salary of Rs. 10 lakhs and hope to retire at the age of 60, you need a life insurance cover of Rs. 3 crores. However, since this method of determining term insurance cover takes future income payments into account, the suggested cover amount is likely to be very high.

Underwriter's Rule Method

A simple rule of thumb that has been around for decades is that your term plan life assured should be equal to at least 10 times your yearly income. So, if Mr. X earns an annual income of Rs. 15 lakhs, they should have a term insurance policy cover of at least Rs. 1.5 crores. However, financial experts say that 10x your annual income is not enough to meet your future goals. You would be much better off with a term plan cover that is 15-20x your yearly salary.

Term insurance policy cover = 15 or 20 x Current annual income

By this math, an adequate term plan cover for Mr. X would be Rs. 2.25-3 crores.

Factors to Consider While Selecting Term Insurance Plan Cover

Calculate your term insurance policy cover in this step-by-step manner:

• Calculate the monthly expenses of your dependents to arrive at future household costs
• Factor in significant outstanding liabilities such as home loans
• Plan future milestones and the fees you are likely to incur while meeting them, such as corpus required for child's education expenses or marriage
• Factor in retirement expenses for your partner, if required
• Calculate your existing assets and wealth that your family would have access to in case of your demise. This includes your PF (Provident Fund), fixed deposits, investments, real estate, gold, mutual funds, etc.

Add your future household expenses, liability payments, future milestone expenses, and retirement corpus. Then, subtract any liquid assets you may have to determine how much total term insurance plan coverage you need.

Getting It Right

Financial planning involves predicting what you can predict from a list of variables. It is possible that as time goes by, your life value increases, the value of your future goals goes up, or your goals change altogether. It is always a good idea to revisit your term insurance policy coverage and amend your term plan accordingly.

When you are younger, you have fewer liabilities, but a beginner's salary also saddles you. As your age increases, so do your responsibilities, and so does your need to insure your life for a more significant amount.

If you purchase a term plan early in life, you benefit from lower-term plan premium rates. Even after buying a term plan, you can always choose to purchase enhanced cover to meet newer calculations.

Some term plans may allow you to enhance your cover at periodic stages in life, such as a child's marriage or birth. If your existing insurance provider does not offer you the chance to enhance your term insurance policy cover, you can bolster an old policy with a new term insurance plan.

The whole process of researching and choosing the best term plan and coverage amount for you is quickly done online. Not only do you get access to all the information, but you can also use online calculators and simulators to understand how your coverage affects the premiums to be paid. Choose a term insurance plan that gives you adequate cover at an affordable cost from a reliable insurer.