How Do You Decide On The Right Cover for Term Plan ?

If you’re looking to buy life insurance, you may have come across term plans. To put it simply– term plans provide your family with a predetermined amount of money in the event of your death. 

With proper term life insurance, you can be assured of your family’s financial security even in your absence. While deciding to buy life insurance is a commendable step on its own, most people find themselves confused when determining the right cover amount for their policy. This is because they think it needs a lot of calculation and consideration. 

But don’t worry, we are here to help.

3 Ways To Think About The Right Cover For Your Term Insurance

1. Human Life Value Method 

In the Human Life Value (HLV) method, your financial contribution over the years is considered to come up with an economic value. This calculation will consider your age, income, and retirement age to calculate an estimated loss your family will incur on your demise. 

2. Income Replacement 

This is a simple calculation method where only your income is considered. You can simply multiply your current income with the years left until your retirement. So, if you earn ₹10 lakhs yearly and have 30 years till retirement, your required coverage will be ₹3 Crore.  

3. Expense Replacement 

This last method is considered the most comprehensive procedure to calculate your term plan coverage requirements. Here, you must calculate your family expenses, life goals, and liabilities. Finally, your ongoing liquid investments are deducted from this sum, giving you the required cover amount. 

Let’s Deep-dive Into Expense Management Methodology

Here is the step-by-step guide to determining the optimal term life insurance cover amount with expense management methodology :

Step 1. Note Your Current Income

First of all, note down your current annual income. To be more specific, calculate your in-hand income per year. This will serve as the foundation stone for estimating your required cover amount.

Step 2. Analyze Monthly Expenses 

Next up – expenses. You need to list every significant expense your family incurs at the moment. Don’t limit the list to essentials like groceries, electricity bills, and rent. Instead, be realistic in your calculation and include impulse and leisurely spending, like Netflix subscriptions, vacation costs, and dinner night expenses.

Step 3. Consider Financial Liabilities 

Have a look at your ongoing liabilities. Do you have a Home loan? A car loan? Or maybe credit card debt? Liabilities like these will not disappear if something were to happen to you. Hence, you need to ensure that your term plan also covers ongoing debt liabilities. 

Step 4. Determine Future Life Goals 

Your family’s future depends on you, even after your demise. Be it your child’s education, upcoming marriages, or your spouse’s post-retirement plans, you need to ensure that these future goals are met even in your absence. Hence, selecting a plan that covers these specific life goals is essential. 

Step 5. Consider Age 

Your age will heavily influence your decision regarding financial dependence coverage. For instance, if you are unmarried and in your 20s, an insurance cover of ₹1 Cr will be more than enough. However, when you get married and have kids in your 30s, your responsibilities will change, where ₹1 Cr will not be enough money to compensate for your absence financially.  

Step 6. Affordable Premium Value

Finally, you should come up with an affordable premium amount. Getting term life insurance will be pointless if costly premiums become a burden. Remember, failing to pay your premiums can lead to policy relapse. 

Let us take an example of Mr. Ravi to understand term plan cover amount calculation. He is looking for a term plan for 30 years. Here is the breakup of expenses he and his family have to bear:

In case of Ravi’s demise, his family’s lifestyle and dreams should not be shattered. So, Mr Ravi would require a final coverage amount of = (₹70 lakhs + ₹80 lakhs + ₹20 lakhs + ₹60 lakhs) –  ₹40 Lakhs = ₹1.9 Cr.

However, it’s also essential to include the inflated value of your liabilities and financial goals for a more accurate result. 

For instance, higher education costs have shown an 11-12% inflation rate.^[1] This means that the current ₹20 lakhs requirement might increase to a higher amount in 30 years. 

Thumb Rule : 10-15X Of Annual Income

If you are the family’s sole breadwinner, your month-on-month salary is the amount currently sustaining your household. Even if you are not the sole breadwinner, your absence from your family will create a void in their total family income. Hence, the rule of thumb suggests your term plan cover amount should be at least 10X to 15X times your current annual income. 

This rule will help you get a ballpark figure for your requirements without delving into much of the calculations we explored in the expense replacement methodology.

Key Takeaways

Remember, there is no one-size-fits-all regarding term insurance benefits and coverage. The goal is to leave behind a financial cushion that helps your loved ones maintain their standard of living, even after your demise. If manual calculation seems too complicated, consider using a term insurance calculator. 

Consider platforms like PhonePe for a seamless and hassle-free insurance purchase experience.