Now that we know why we need to buy term insurance, the next question will be how much term insurance do I need?
In the previous article, you found out that you buy a term insurance policy if you are convinced that your absence will create a huge financial burden for your loved ones.
A term insurance plan reduces this financial burden as the insurer pays them a sum if God forbid something happens to you.
The next step in buying a term insurance policy is to find out how much insurance to buy?
When you check online, most of the calculators ask you to fill your age, retirement age, number of dependents, annual income and your existing life cover (optional). Then they ask to fill the value of your assets and how much money you owe or your loans or your liabilities.
This calculates the insurance cover you need. Let's say the calculator says INR 1.5cr, we will try and find out if that number is enough.
To do that, I urge you to answer these questions:
- How much do you (and your family) spend every month?
2. Do you have any other sources of income that can replace your income if it stops permanently?
3. Are you expecting your expenses to increase in the future?
My elder son is in Grade 10 now and I am expecting his education cost to increase in 3 years.
4. Are you only expecting the education cost to increase? What about unplanned expenses such as travel, health, and so on that you may have to incur in future?
5. Do you have more dependents?
In my case, my younger son is in Grade 7 now and I am expecting his education cost also to increase in the next 6 years.
6. How much assets do you own to take care of these inflated expenses?
7. How do you rate your dependents' financial wellbeing? To answer this question, consider all aspects such as financial capability - skills and knowledge, access to financial products, income and social capital. Read more here.
This is very important because the fixed sum received from the insurance company must be reinvested so that they can sustain themselves. If you draw from that amount, it won't last very long.
If their knowledge of financial products is limited to safe instruments like Fixed Deposits, currently investing a corpus of INR 1.5 cr in an FD gives you a 5% return (INR 7.5 lakhs) which may not be enough to sustain their expenses.
Asking questions will help you understand how much term insurance you need?
Don't stop here, write down more questions - curious questions that you might have on this topic and try to find answers. If you can classify the knowns and unknowns, you will be able to look at the picture very clearly.
Find out if 10 times your income is a good approximation to calculate how much term insurance you need?
Let me know your thoughts or comments by writing back to me at email@example.com