Once you’ve decided that you need life insurance, the important question that arises is how much cover to take. Unless you take adequate cover, your family will not be well provided for after your passing.
You can arrive at the right cover by calculating human life value (HLV) or you can take the simpler route of going by certain thumb rules. You can use income replacement and need-based calculators to determine the ideal cover amount.
To start with, however, here’s a simple guide to key factors to help estimate the cover amount (sum assured in insurance parlance) that would be adequate to protect your family’s financial interests in case of your death.
Annual salary
One common benchmark used to calculate the amount of life cover is your annual salary. Typically, life cover of 10 times your annual salary is assumed to be good enough. However, this may not be sufficient for everyone.
Rhishabh Garg, head of term insurance at Policybazaar.com, suggests 10-20 times your annual income as the golden rule of thumb. Assume you have an annual income of Rs 10 lakh and your expenses are Rs 6 lakh. If we account for a 7.5 percent inflation rate, your expenses will double every 10 years. Then, over 20 years, you will need Rs 1.8 crore (Rs 60 lakh plus Rs 1.2 crore) for expenses. This is 18 times your current annual income.
“For higher net-worth individuals who have already built an asset base, a 10-12 times multiple may work, but for those with lower incomes, something like 15-20 times may be better,” said Garg.
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Age
The purpose of life insurance is to provide income replacement – financial protection to your family during your active work-life years – if something were to happen to you during this time. Typically, people tend to take a life insurance policy that covers them until 60/65 years – through their working life.
“The idea of life insurance is to protect the earning member through his earning years. A thumb rule is to go up till 60 years. Going beyond that will mean that the premium will go up,” said Kalpesh Ashar, a registered investment advisor.
To start with, your requirement for life insurance may be limited, but as you cross certain milestones (get married, have children), your need for life insurance is likely to go up. At that stage, your earnings and investments may not be enough to cover your family’s expenses. Then, as your financial responsibilities are dealt with and as you build your savings and asset base, your need for life insurance may go down.
“You could take a life cover of 15 times your annual income if you are aged 35-40. Beyond 40 years, a cover of 10-12 times your income may be enough,” said Suresh Sadagopan, managing director of Ladder7 Wealth Planners.
Expenses and goals
While your annual income and current age can give you some indication of your life insurance requirements, Sadagopan suggests going beyond these metrics. What matters is not how much you earn but how much you spend.
“We go by expenses and goal replacement," said Sadagopan. “What is the amount that a family will need to meet its regular expenses and various goals in life (such as children’s education, buying a car) over the next 20 years or so? This amount must be adjusted for inflation. Then, add your liabilities such as any loans, and subtract any savings and assets that can be liquidated to arrive at the final amount needed.”
If you have an outstanding loan of Rs 50 lakh, you must include this amount while calculating the sum assured. If you have already saved Rs 10 lakh of a planned Rs 30 lakh for your child’s education, you need to add Rs 20 lakh or an even smaller amount to your calculations. If your child’s education is still a few years away, the Rs 10 lakh will grow into a larger sum if invested appropriately.
On the other hand, if you have financial assets such as fixed deposits totalling Rs 30 lakh, you can subtract this amount from your sum assured calculations.
Ashar suggests that one could consider taking two separate policies – one to meet family expenses and another to meet any liability such as a home loan. That way, the family knows what amount is demarcated for what purpose.
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Working spouse
Another factor to consider is whether one or both partners are working and earning.
“If both are working, I advise each to get suitably covered because both their incomes are being used for the family’s expenses,” said Ashar.
Logically, it may seem that you can go for a smaller life cover if you have a working spouse. However, Sadagopan said that practically, families with two earning members have different lifestyle aspirations that need to be taken into account for a life insurance cover. In short, both need adequate life cover to secure the family’s financial future in case of any unfortunate event.
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While it’s best to go by an estimate of your total expenses to calculate your life insurance cover (sum assured), you can rely on a multiple of your annual income to give you a ballpark number. Experts suggest 15 times your annual income to be a safe number.
Also, remember to review your life insurance cover once every few years, especially after a major life event. With time, your expenses, goals and aspirations may change, and what may be the right sum assured today may not be so a few years down the line.
Also read: Does life insurance make sense without tax benefits?
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