An insurance cover amount that looks sufficient today may not adequately protect your family once you account for your home loan, other such liabilities and the income your family depends on. Therefore, choosing the right term insurance cover is one of the most crucial aspects of financial planning.
A practical approach is to look at your financial obligations alongside your earning capacity and existing assets. This helps you estimate how much money your family may need if you and your income is no longer available to provide for them.
The key is to discover a way to estimate the term insurance cover you may need based on your income, home loan, liabilities, and existing financial resources.
What Should Your Term Insurance Cover Account For?
There is no universal coverage amount that works for every individual. Your ideal term insurance cover is the one that reflects your family’s financial responsibilities, outstanding debts, any future liabilities and the resources you already have.
When estimating the coverage of your home loan insurance, consider these four key factors.
- Your family’s ongoing expenses may depend on your income. The cover should provide enough financial support to replace a portion of your future earnings.
- As your home loan is one of the most significant liabilities, you must consider it along with other debts like a personal loan or car loan that your family may have to repay.
- Consider expenses such as your marriage, your children’s education, their marriage and other such major events that may depend on your future income.
- Your savings, investments and existing life insurance policy can reduce the additional coverage you may otherwise need.
Looking at all the four factors will give you a more realistic estimate than choosing a cover based solely on your annual income. Now let us understand each of these factors in detail.
1. Calculate Your Income Replacement Need
Your income is one of your family’s most important financial assets. When you are no longer there to earn it, then it is your term insurance that should provide financial support enough to help your family maintain their financial stability.
A simple starting point is to consider your annual income and the number of years your family may need financial support for.
For example, if you earn ₹15 lakh a year and have 20 years left until your planned retirement, your future income potential would be ₹3 crore.
However, this does not mean you need a complete ₹3 crore term insurance. Your actual requirement will depend on other factors as well. For instance if there is another earning member in your family, then that changes the dynamics. Therefore, you need to factor out your family’s annual expenses, expected income growth, inflation, existing investments, and other possible sources of income.
You can therefore use your income and remaining working years as a starting point rather than treating the calculation as a fixed rule.
Once you have a broad indication of the income your family could lose after you, you then move on to consider the other three factors that are your home loan and other such liabilities, financial goals, and existing assets.
2. Add Your Outstanding Liabilities
Your term insurance should also account for debts that could become a financial burden for your family. A home loan is often the largest liability for working professionals but you may also have personal loans, education loans, or other significant outstanding debt. Start by listing these major liabilities that would need to be repaid in your absence.
For example you have an outstanding home loan of ₹50 lakh, a personal loan of ₹5 lakh and some other liabilities accounting to ₹2 lakh. Adding them all gives a total of ₹57 lakh in liabilities.
This amount of ₹57 lakh can be added to the income replacement requirement you first estimated. Doing so helps ensure that your family doesn’t have to use their savings to repay your debts after your death.
However, don’t just simply add every small or short-term debt to your coverage. This needs to be strategically done by focusing on significant and especially the long-term liabilities.
3. Account for Your Future Financial Goals
Your family may have financial goals that are still years away. When you’re gone and your income is no longer available, these goals could become an unfulfilled dream.
Think about goals such as your children’s education, from school and college to higher education expenses. Their marriage is another significant financial responsibility. If your spouse depends on your income, then their financial needs have to be considered. Think of any major financial commitments that your family may need to meet in the future.
However, avoid adding every future expense to the calculation. Do not include events that your family would be capable of achieving in your absence. Focus on significant goals that would be difficult for your family to fund without your income.
The idea is simple, your term insurance should help protect not just your family’s present financial position, but also the important goals you were working towards together.
4. Subtract Your Existing Assets and Life Cover
Once you’ve estimated all the above three factors, it’s time to list the financial resources you already have. These may considerably reduce the amount of additional term insurance depending on the savings and investments you and your family made.
What all you can include here is any existing life insurance policies and savings like bank deposits, emergency savings, and other readily available funds.
Investments like mutual funds, stocks, bonds and fixed deposits should also be included. If you have any other financial assets like a real estate property, you can include its value as well.
However, not each and every asset should automatically be deducted from your insurance requirement. Analyse whether the asset will actually be available to your family, how easily it can be accessed, and whether it is already earmarked for another financial goal.
Is 10–15 Times Your Annual Income Enough?
You may have heard the general rule that your term insurance cover should be around 10–15 times your annual income. While this can be a useful starting point, it may not actually account for your complete financial situation.
For instance two professionals earning ₹15 lakh a year may have very different insurance needs. One may have a ₹60 lakh home loan and two dependents, while the other may have no major debt and substantial investments.
That’s why it’s better to look beyond your income and consider your home loan and any other debt. The number of people that financially depend on you is a major point of consideration as you need to plan for your entire family’s future financial goals.
Finally, you need to analyse if there are any existing savings and investments or any current life insurance policy. These are financial assets whose value you need to deduct from your estimate of the term insurance coverage.
An income multiple can give you a quick estimate, but a personalized calculation can provide a more realistic picture of the coverage your family may need.
