How to Calculate Life Insurance Coverage
When shopping for insurance, there is one important question to consider: what is your life worth? This is a tough question to ponder. But it is an important one. The resulting numerical amount is salient in estimating the financial support that your family will require if anything untoward happens to you. But how do you come upon this figure? There are several ways to do so. And choosing the right one is key to providing adequate support to your loved ones in their times of need.
What is Life Insurance?
A life insurance plan is a contract between an insurance company and an insured party. The insurer agrees to pay a stipulated amount upon the death of the insured person on the condition that all premiums are paid. Life insurance may also provide a financial cover for a possibility linked to human life such as disability, retirement, accident, and so on. Certain types of life insurance also provide financial benefits when an insured party passes an agreed-upon period called the maturity period. This amount called the maturity benefit is passed on directly to the insured party.
Who Should Take Life Insurance?
When it comes to life insurance, everybody stands to gain by purchasing coverage. The kind of life insurance plan you choose depends on your goals and your stage of life. The main goal of life insurance is to secure your family’s financial future should you pass away. This is a way to ensure that your family is protected and they can maintain their lifestyle and daily expenses. Life insurance also has secondary benefits, such as tax-saving and wealth creation.
Young unmarried adults can purchase a life insurance plan that helps to create a corpus over time, such as endowment plans and Unit-linked Insurance Policies. New and existing families should take insurance especially since they would have dependents and insurance can be used to protect your family and achieve financial stability. Even if your company provides you with life insurance coverage, you should take life insurance coverage. The reason is that if you are terminated or you leave your job, then your insurance coverage will end. Also, your employee insurance coverage may not provide coverage to your family members.
Self-employed or business-owners should purchase life insurance. Both types may have unreliable sources of income. Life insurance can provide a form of stability as well as an investment opportunity. You may have people relying on you; life insurance can be a source of security for them. Life insurance can be a boon for senior citizens. There are annuity life insurance plans that provide regular income for senior citizens.
So, life insurance coverage can and should be purchased by everyone and at any stage of life.
The Broad Rule of Thumb for Life Insurance Coverage
Calculate your coverage by multiplying your current income by 10. This is an often-stated broad rule of thumb. And it is perhaps the quickest way to calculate your life insurance coverage. However, some experts advise that people aim for 12–15 times their income. While a few even suggest going as high as up to 20 times their current income. Given the high rates of inflation and high costs of living nowadays, the higher numbers seem appropriate.
This ‘10–20 times income’ rule is the easiest way to come to a number. But it leaves you at the risk of being either under-insured or over-insured. Neither scenario is to your benefit. The thumb rule does not consider your family’s unique financial requirements. Neither does it consider your current or future savings and debts. Moreover, the rule does not account for a stay-at-home parent who needs coverage even when not actively earning an income.
In short, while being quick and easy, the thumb rule does not account for a detailed overview of your family’s finances and requirements.
How to Calculate Your Life Insurance Coverage?
There are four steps to calculating your life insurance coverage. Use the examples provided below to account for your own family’s needs:
- Calculate your family income –
Below is a table illustrating the first step of the process.
| A | Your monthly income | Rs 80,000 |
| B | Multiply your monthly income by 80% which represents the percentage of income you wish to cover | Rs 64,000 |
| C | Your spouse’s monthly income plus any provident fund and employee fund benefits | Rs 45,000 |
| D | Subtract row C from row B to get the monthly shortfall your beneficiaries would face | Rs 19,000 |
| E | Multiply row D by 12 to get an annualised amount | Rs 22,8000 |
| F | Multiply row E by the number of years that your beneficiaries would need the income replacement for (this number goes down as you get older) | (For 20 years) Rs 45,60,000 |
| Sum total of your family’s financial needs | Rs 45,60,000 |
- Calculate your family’s regular and one-time/arbitrary requirements –
This is where you will account for non-recurring expenses such as a child’s weddings, a car loan, and so on. It also accounts for your monthly expenses which include groceries, rent, tuition fees, and so on. You can use the table below as is or add or subtract the rows/requirements as you see fit.
| Child’s wedding expenses | Rs 40,00,000 |
| Child’s college education fees | Rs 30,00,000 |
| Home loan | Rs 65,00,000 |
| Car loan | Rs 5,55,000 |
| Personal loan | Rs 85,000 |
| Other expenses | - |
| Monthly expenses in full | Rs 75,70,000 |
| Total requirement | Rs 2,17,10,000 |
- Calculate your current assets -
Here you will add up every asset you own including your cash savings, any PPF investments, property value, stocks/shares, mutual funds, and so on. Again, you can add or subtract rows depending on what suits your current situation
| Savings (in cash form or a bank savings account) | Rs 4,50,000 |
| Current property value minus any outstanding loan amount | Rs 2,00,0000 |
| Retirement plans in the form of PPF, PF, etc. | Rs 7,35,000 |
| Investments in mutual funds, stocks, etc. | Rs 10,50,000 |
| Other assets | Rs 9,00,000 |
| Total current assets | Rs 51,35,000 |
- Your final calculation for your life insurance coverage amount –
| Sum total of your family’s financial needs | Rs 2,17,10,000 |
| Total current assets | Rs 51,35,000 |
| Insurance coverage amount | Rs 1,65,75,000 |
Points to Consider When Buying Life Insurance Coverage
- Make it part of your financial plan:
Make your life insurance purchase a part of your overall long-term financial plan. This long-term plan should include long-term goals such as future education costs as well as the expansion of your investment corpus. This is why the above calculations feature a detailed breakdown of your current and future income, assets, and expenses. - Don’t be stingy:
One of the worst things to do is to be under-insured. Inflation has been at an all-time high. Medical costs and education costs have especially high inflation rates, which see no slowing down in the near future. For your family to survive comfortably in your absence, you must account for rising costs. Your coverage amount should allow your family to maintain their existing lifestyles. They should not be bogged down with debts that will undermine their financial comfort and future. At the same time, these careful calculations should help you avoid over-insuring yourself. You don’t want to be in a position where you are paying very high premiums for an unnecessarily high coverage amount. - Consult your spouse:
If you are married, go through the numbers and calculations with them. For example, do they agree on the percentage of your income that would need to be replaced or would a higher/lower number be required? - Consider the type of insurance:
There are multiple types of insurance available today. Each type caters to different needs. If you want low premiums and basic insurance coverage with no added benefits, then term insurance may be the one for you. Or perhaps you want one with maturity benefits, an endowment plan could be ideal. If you want regular income, the money-back insurance plans would interest you. If you are a senior citizen or quickly approaching retirement, then annuity plans could be your deal. Go through all the different types of insurance available and choose the one that suits your requirements the most. - Start early:
The earlier you start the better. Buying life insurance early could mean the difference of thousands of rupees in premium payments. Younger people are usually charged lower premiums as they have health and youth on their side. Older adults usually have to pay much higher rates for the same coverage amount. - Revise your amount, if needed:
There are several reasons you may need to revise your coverage amount. Perhaps you bought insurance when very young and now you are older, married, and have children. Your insurance cover should provide for your new family members. Or you may have shifted from a service occupation to owning a business/self-employed. When you are self-employed in any way, you tend to lose certain benefits that the organised sector gives their employees. Your insurance coverage could make up for this loss by reflecting a higher coverage amount.
The Bottom Line
Buying health insurance has become greatly simplified with the availability of online insurance plans. You can use the abundance of information online to choose the best insurance plan for you and your family. Remember, however, no plan can make up for faulty coverage. Don’t choose the easy way out. Use the above tips to estimate the coverage amount that would be best for your circumstances. A pure term plan can form the foundation of your insurance portfolio. After that, you can also purchase an endowment plan, or Unit-linked Insurance Policy (ULIP) to provide further coverage and investment. Whatever you choose, take the time to calculate your coverage!
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