Four Methods To Calculate How Much Term Insurance You Need
When you are planning the financial safety of your family, you would want to buy a good life insurance policy. There are many types of life insurance policies that you can select from. The most suitable and easily affordable types a term insurance. While you would find different varieties of it, you need to know which plan would be suitable for you based on your requirements. Read more to understand the methods that could help you calculate the amount of sum assured you need from your policy for the best financial protection.
What is term insurance?
Term insurance is a type of life insurance policy that indicates an agreement between the insurer and the policyholder. As per this agreement, if the policyholder were to pass away during the policy term, the insurer compensates the family of the policyholder with a sum assured. This amount can help the family of the policyholder manage daily expenses while staying financially protected from different life risks.
Why do you need to calculate the sum assured?
No two people have the same insurance requirement. Based on their lifestyle, life goals, and other requirements, the policy needs of one person will differ from another. Due to this, one needs to know how much sum assured they actually require. If you were to opt for a policy with a higher sum assured, keep in mind that the cost of that policy will also be higher. On the other hand, if you opted for a low-cost plan, you might get a lower amount as the sum assured.
In order to calculate the amount of sum assured you would require from your insurance policy, you can use either of the 4 methods:
1. Income replacement method
This method is used to calculate how much sum assured would be required in the event of the loss of income due to the demise of the policyholder. If your policy were to replace your source of income, this method is used for that calculation. The formula for this is:
Current annual income x years left before retirement= Insurance cover
For example, if you are 35 years old and your annual income is Rs 12 lakhs; you plan to retire by the age of 58. So, as per the formula given above, your required life insurance cover from the policy would be Rs. 2.76 crores.
While this method might give you a rough idea about how much sum assured you would require to replace your income, it might not give you an accurate figure. Chances are that it might suggest a higher amount of sum assured than required.
2. Human life value
The main objective of this method is to give you a figure of sum assured based on the human life value (HLV). Basically, if you are the sole breadwinner of your family, this method is used to calculate your HLV towards your family. The factors that are considered in this method include your income, household, medical expenses, and your future life goals. A great advantage that this method has is that it takes inflation into account while doing calculations.
Depending on your family’s lifestyle , and whether you plan on maintaining it or changing it in the future can help you in getting an idea about the life cover with this method. Insurers recommend and use this method.
3. Underwriter’s rule
In this method, you go by the basic assumption that you will require a sum assured that would be 10 times more than your income. For example, if your current annual income is Rs. 5 lakhs, your required sum assured would be Rs. 50 lakhs. However, the biggest flaw with this method is that it undermines the requirement of sum assured. The usual thumb rule is that your sum assured should be at least 15-20 times more than your income.
If you purchase a policy with a lower sum assured and your insurer offers the option of increasing the sum assured, you should take advantage of it. Changes in life goals at different life stages will require an enhanced life cover. Do keep in mind that an increase in the life cover also increases your policy premium. If this feature is not present in your policy, you might be required to opt for a second policy.
4. Expense replacement
This method helps you in getting the amount of life cover that would match all the necessary expenses of your household in your absence. These expenses are not just limited to the day-to-day cost of living. This includes medical expenses, repayment of loans or debts, financial planning of your children’s future, and securing the future of any other dependents. Once you calculate on the basis of these factors, the amount you get is the life cover amount you require. Deducting your investments and insurance from these expenses will give you the amount of life cover you should ideally go for.
These are some methods that you can use to calculate the amount of life cover you would require from your policy. If you plan on purchasing this policy, you can use the term insurance plan calculator to see the cost of your plan based on your requirements.