Note: This is post #200 on this blog. This milestone has been reached in 21 months since the day of starting this blog in March 2021. I wish to thank all my readers for their continued support.
Why do you need term insurance?
Term insurance is a type of life insurance that pays a benefit to the named beneficiaries in the event of the insured person’s death, as long as the policy is active. The purpose of term insurance is to provide financial protection for the policyholder’s loved ones in the event of their unexpected death, helping to cover daily expenses, future goals such as children’s education, and loans like home loans.
It is a straightforward insurance product, similar to car insurance, in that it only pays out in the event of a specific occurrence (death) and does not have a savings component like other types of life insurance. The cost of a term insurance policy is generally low compared to the potential benefit, and the recommended coverage amount is typically 20 times the policyholder’s annual after-tax income.
Insurance allows risk transfer from a single person to a group of people. Since many people buy insurance, only some are expected to die within the policy’s coverage time. However, it should be present at least for all earning members of the family before retirement age.
This article shows you how to calculate the coverage amount that you need.
How much term insurance do you need?
As a thumb rule, typically, coverage will be 15-25x current annual income after tax.
There are two ways of calculating insurance coverage/sum assured needed. The coverage required typically changes every few years since financial goals and life events (like marriage, the birth of a child etc. happen) change the requirement. Please review the term coverage needed every 3-4 years. The method of calculation of coverage required is called Human Life Value (HLV) method.
HLV Income method
Use a tool like Excel or Google Sheets to calculate using the following formula:
The real rate depends on the industry and salary growth potential vs inflation in the country. A value like 0-2% can be assumed. If the real rate is assumed to be 0%, then the coverage amount is simply Income multiplied by Years_to_retire
Years_to_retire indicates how much time is left until retirement, typically from today to 55-60
AfterTaxAnnualIncome is the in-hand salary (plus components of EPF) that are received every year
Example:
Someone currently 32 years old in a high growth industry expecting to retire at 55 and having an after-tax annual income of 20 lakhs needs coverage of
PV(0%,55-32,-20,0,1) = 4.6cr.
If they already have a 1cr term plan, then you should take additional 3.5cr coverage.
minus the personal needs of the person being insured
minus any EMI being paid
minus any insurance premiums being paid
Example: (using the exact figures from above)
If a spouse spends 30 years in retirement where the real rate of return is 0% (a reasonable assumption), 33 lakhs in home loan outstanding, 80 lakhs in investments (stocks/mutual funds/FD etc. but not house) having 1cr current term insurance will need
Current_Annual_Expenses =
In hand salary less personal needs of the person being insured (20 lakhs salary less two lakhs personal expenses)
less any EMI being paid (25k/month, i.e. three lakhs/year for a home loan)
less any insurance premiums being paid (11k/year for 1cr term plan)
the shortfall of current goals. If income stops, this amount, if invested, will fund current goals
the amount needed to sustain a retirement-level lifestyle, including inflation adjustment, for the period income was expected to be there.
This figure is the minimum since you need to add any ongoing outstanding secured loans (like home or car loans) or loans where family members may be co-borrowers to this coverage amount. This means that if you have 30 lakhs in an outstanding home/car loan or an educational loan of 10 lakhs with parents as co-borrowers, add those amounts to the term insurance coverage.
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We have put together an easy-to-use calculator to calculate the coverage amount. The number will be approximate and will depend on the quality of the inputs that you enter into the calculator.
Important: You should enter data only in the yellow cells. If any cell is not relevant to you, please enter 0 to erase the number in the cell.
Step 1: Enter basic information
Box 1: Enter your name.
Box 2: Desired retirement age: this can be either the company-mandated age of 58 or 60 or the age you wish to take early retirement
Box 3: If you already have personal, i.e. not company-provided life insurance, enter the covered amount here. If you don’t have any, enter 0. The number is in ₹ lakhs
Step 2: Do you have dependents?
Box 4: This is a Yes/No choice. Generally, if you do not have dependents, you do not need term insurance unless you have loans.
Step 3: Enter income and expense details
Box 5: In hand monthly salary after tax
Box 6: Employee provident fund (EPF) and NPS deductions if any per month
Box 7: Annual bonus if any. This is yearly and not monthly
Box 8: How much income growth potential do you have in your current industry? This is perception based and is the same real-rate figure mentioned above in the HLV Income section. Leave this at High if you do not know.
Box 9: The real rate of return for the retirement portfolio will be 0% for most people. Do not change this. If you do, you need to create a very aggressive portfolio that may or may not suit your retirement goal
Box 10: How much time are you expected to spend in retirement? This is a function of starting age for retirement and longevity. You should assume a high figure under normal circumstances
Box 11: The money you spend today for the whole year apart from personal expenses, EMI and insurance premiums for yourself. If your family expense is ₹5 lakhs/year and you spend ₹30,000 for your own insurance and ₹70,000 for personal expenses, enter ₹4 lakhs here
Step 4: Enter goals
This is for Box 12 and is an important section. If you do not fill this out correctly, you will underestimate the amount of insurance coverage needed. The value should be the target corpus of future financial goals, projected to the present. For example, if you need 10 lakhs in 5 years and can invest at 5% post-tax returns, the value will be ₹10/(1.05)^5 = ₹7.8 lakhs.
You can enter goals in the table one after the other. The total will be added and fed into the calculation.
Similarly, you need to enter the current outstanding amounts of all loans. For example, if you have a ₹70 lakhs home loan and have already paid off ₹20 lakhs, then enter 50 here.
Step 5: Enter the market value of your assets
This is for boxes 14 and 15. You need to enter the market value of all your assets. For real estate, the market value of your primary residence is not included in the calculation since you do not expect your family to sell their home since you died.
The result will be calculated and shown to you in the middle of the page. The number you see, in lakhs, is the additional coverage amount. If you are buying a new policy today, the coverage should be around this number. If the number comes to be very low or zero, you do not need term insurance coverage as explained here: How your term insurance coverage changes with time.
Get the calculator
Since the calculator uses Google Sheets, you need to be logged into your Google Account on a browser before clicking the link.
Link to the calculator: here. You will get the calculator, which is free for use, in the “term-insurance” sheet.
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This post titled How to calculate term insurance coverage amount? first appeared on 13 Nov 2022 at https://arthgyaan.com
