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5 methods to calculate how much term insurance you need

Choosing the right term cover can be confusing and overwhelming for some. After all, it is about your family's financial security. Here are five ways of calculating the right term cover.

  • 2,940 Views | Updated on: May 10, 2024

Updated On: 28th August, 2023

Term life insurance is one of the most affordable ways to secure your family’s future. However, the policy is only as good as the cover. Keep reading to know the top five ways to calculate the appropriate term life cover.

Key takeaways

  • One of the most commonly used ways to determine the appropriate term life cover is by multiplying your current annual salary by 10-20 times.
  • To get your life cover, you have to multiply your current annual salary by the number of years left to retire.
  • Calculate the life cover by finding out your total household expenses now and in future, adding your liabilities and deducting your investments and assets.
  • List down all your future plans and the money you will need to achieve these goals. Then, subtract the assets you already hold to calculate the life cover to help your family meet all the financial goals.
  • One of the best ways is to calculate the human life value of the policyholder.

What is the Meaning of the Term Insurance Coverage?

Term insurance coverage, often referred to simply as “term life insurance coverage,” is a type of life insurance policy that provides coverage for a specified period, or term, of time. Unlike permanent life insurance policies that provide coverage for the entirety of a person’s life, term insurance offers protection for a predetermined duration. If the policyholder passes away during the term, the beneficiaries receive a death benefit payout.

5 Methods of Calculating the Right Term Cover

Selecting an appropriate term cover for your life insurance is a critical financial decision that ensures the financial security of your loved ones in the event of your untimely demise. A term life insurance policy provides a fixed sum assured to your beneficiaries upon your death during the policy term.

Thumb Rule

One of the most commonly used ways to determine the appropriate term life cover is by multiplying your current annual salary by 10-20 times. While this method is the easiest way to calculate the cover, it may not be the most accurate method. This is because it doesn’t consider other factors, such as future liabilities or meeting financial goals.

Years to Retirement

This method is very similar to the previous rule, but the multiplier is decided based on the years left for the policyholder to retire. To get your life cover, you have to multiply your current annual salary by the number of years left to retire. While this method is also relatively easy, it again may give you an inaccurate cover as it is based on your current annual income and years left to retire. 

Expense and Liabilities Replacement

This method stems from the concept that term life cover should take care of the family’s future expenses and liabilities in case of the policyholder’s death. In this method, you can calculate the life cover by finding out your total household expenses now and in future, adding your liabilities and deducting your investments and assets apart from the ones already in use by your family. This is a slightly more accurate method of calculating the life cover but it can be complicated for a few people.

Meeting the Financial Goals

Very similar to the previous method, this looks to meet the financial goals rather than the expenses and liabilities. In this method, you can list down all your future plans and the money you will need to achieve these goals. Once you have that, you can subtract the assets you already hold to calculate the life cover to help your family meet all the financial goals.

Human Life Value (HLV) Method

One of the best ways is to calculate the human life value of the policyholder. This considers various factors such as your current income, your future expenses, liabilities, assets, and goals to come out with a figure that helps determine the financial loss a family may face in case of the policyholder’s death. While it may sound complex, there are HLV calculators online to help you know the term life cover easily and quickly.  

Points to Note While Calculating Your Term Insurance Cover

Determining the appropriate term insurance coverage is a critical decision that requires careful consideration of various factors to ensure your family’s financial well-being. Let’s delve into the key points you should keep in mind while calculating your term insurance coverage.

Income Replacement

One of the primary objectives of term insurance is to replace your income and maintain your family’s standard of living if you’re no longer there to provide for them. Consider your current income, future income growth, and potential inflation when deciding on the coverage amount. A common rule of thumb is to aim for a coverage amount that is at least 10-15 times your annual income.

Outstanding Debts and Liabilities

Factor in any outstanding debts, such as mortgages, loans, or credit card balances, that your family would be responsible for in your absence. Your term insurance coverage should be sufficient to cover these financial obligations, preventing your loved ones from being burdened by debt.

Dependent’s Needs

Take into account the needs of your dependents, including your spouse, children, or elderly parents. Consider their living expenses, education costs, medical expenses, and any other financial responsibilities you currently provide for.

Future Goals and Aspirations

Plan for your family’s long-term goals and aspirations, such as higher education for your children, buying a home, or retirement. Your term insurance cover should contribute towards fulfilling these goals even if you’re not around.

Inflation

Remember that the cost of living tends to increase over time due to inflation. The coverage amount you choose today should account for the potential rise in living expenses over the years.

How Does Term Insurance Coverage Work for an Individual?

Choosing the Coverage Amount

When purchasing term insurance, individuals need to determine the amount of coverage they require. This is often based on factors such as outstanding debts, future financial goals (such as funding a child’s education), and the income needed to support the beneficiaries’ lifestyle in the insured’s absence.

Selecting the Term

The term of the policy can vary, usually ranging from 5 to 30 years. Policyholders should consider their age, financial obligations, and long-term goals when choosing the term. A longer term provides coverage for a more extended period but may result in higher premiums.

Paying Premiums

Policyholders pay regular premiums (monthly, quarterly, or annually) to keep the coverage active. The premium amount is determined based on factors such as the policyholder’s age, health, coverage amount, and term length. Premiums for term insurance are generally lower compared to permanent life insurance policies.

Death Benefit Payout

If the insured passes away during the term, the beneficiaries named in the policy receive the death benefit. This payout can provide financial support to cover immediate expenses, outstanding debts, and long-term financial needs.

Wrapping Up

Selecting the right term insurance coverage is a critical decision that requires careful consideration of various factors. By using methods like Human Life Value, Needs Analysis, Income Replacement, Debt-based, and Financial Goal-based, you can accurately determine the amount of term insurance you need to safeguard your family’s financial well-being. It’s essential to regularly review and adjust your coverage as your circumstances change to ensure that your loved ones are adequately protected in any eventuality. Remember, a well-calculated term insurance policy offers a vital safety net that can provide your family with the support they need during challenging times.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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