How much life insurance do you need?

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As we get ready to launch PrimeInvestor’s insurance module, we thought we should start with answering your basic questions on insurance first. So here is the first article in a five-part series that will tell you all you need to know about how you should go about choosing a term insurance plan.

  • Thumb rules like 10x or15x your income may leave you underinsured
  • Instead, think of a term insurance plan as replacement for your income in your absence
  • This involves estimating family expenses and adjusting for family goals, outstanding debt and assets

One of the very first questions you’ll be faced with after deciding to buy a life insurance plan, is – What’s the size of the term cover (what insurers call the sum assured) you’ll need?

life insurance

Most folks don’t put much thought into this and go for the nice round number suggested by their insurance agent, which is usually Rs 1 crore. You can online calculators, but they can throw up widely diverging numbers.

For a 45-year old woman with Rs 15 lakh annual income, one insurer’s website suggested a term cover of Rs 1 crore, while another plumbed for as much as Rs 3 crore. Such numbers are based on the thumb rule which says that you simply need to multiply your annual income by a factor of 10, 15 or 20 to get to your desired insurance cover.

But given that your term insurance is unique to your life situation and family needs, it pays to put a little more thought into it. A very small number may leave your family under-prepared. A gargantuan one will be a needless drain on your savings, given that annual premiums you pay won’t come back.

If you are willing to put a little bit of maths into it, here’s a three-step process to arrive at a customised cover.  

You asked and we have delivered – Now, there is a term-insurance requirement estimation calculator based on the process in this article. Check it out here: Term Insurance Calculator

Replacing income

The primary purpose of a term life cover is to replace your contribution to your family finances. The lumpsum that the insurer pays out needs to be sufficient to ensure that your family or dependants miss you, but don’t miss the money you were bringing home in the event of your death.

The first step to calculating the size of your term cover is to estimate the monthly expenses your family or dependants need to maintain a reasonable standard of living in your absence. 

Therefore, the first step to calculating the size of your term cover is to estimate the monthly expenses your family or dependants need to maintain a reasonable standard of living in your absence. Here’s how you can arrive at this number:

  • First, reduce your own contribution to the household expenses. If your household presently gets by on Rs 1 lakh a month and your personal spends are Rs 30,000 a month, you should budget to replace Rs 70,000 a month through a term insurance plan.
  • If your spouse or other family member is contributing towards those expenses, you can deduct that from the required amount.
  • Multiply these annual expenses by the number of years left in your working life, to arrive at the cover. This is the period for which you are looking to replace your income.  

To illustrate, take the case of Mr Rao who is currently 40 years old, has 20 years to go to retirement and has estimated his family’s expenses at Rs 100,000 a month, Rs 30,000 of which goes towards his own expenses.  A good starting number for his term cover would be Rs 1.68 crore (annual expenses of Rs 8.4 lakh multiplied by 20 years of his remaining earning capacity). If he were only 30, he’ll need a larger cover because he’ll need to replace more years of income. If Mr Rao was 50, he’d need less.

While the above calculation assumes that Mr Rao’s family can get by on their current level of expenses for the next 20 years, you have to admit this is unrealistic, because he’s not budgeting for inflation. To get to a realistic term cover, therefore, it would be desirable to adjust your family’s expenses for inflation for the period for which they need income replacement.

In the above example, if Mr Rao budgets for 5% annual inflation, his family would start at Rs 8.4 lakh a year but end up spending Rs 21.22 lakh a year 20 years from now. Adding up the likely expenses for the family over the next 20 years after budgeting for inflation, leads to a term cover requirement of Rs 2.77 crore to replace Mr Rao’s contributions.

The above number can further be reduced if Mr Rao expects any of his dependants to stop relying on him in future. Suppose his 10-year old daughter can be expected to become financially independent by the time she’s 25, Mr Rao can budget for his family expenses to shrink by say, 20%, after year 15. If he has dependant parents with a remaining life expectancy of 15 years, that could call for downward revisions too.

Even without getting into such nitty-gritties, you can arrive at a reasonable term cover by simply extrapolating your family’ expenses for your remaining working years, using an inflation assumption.   

Meeting goals

The above exercise takes care of your family’s living expenses, but what about their financial goals that you were hoping to fund with your future savings? These need to be funded by your term cover too.

Let’s assume Mr Rao was investing towards a Rs 30 lakh education fund for his daughter Mridula’s graduate and post graduate degrees when she turned 18. His early demise will leave this goal unfulfilled. That’s clearly not acceptable.  So, this risk must be mitigated by adding in the unfunded portion of Mridula’s education goal into his term cover too.

buy hold sell

Suppose Mr Rao had Rs 10 lakh already invested in his daughter’s education fund, he first needs to estimate how much this would grow to, at a conservative rate of return when the goal comes up. Assuming Mridula needs the money when she’s 18, there are 8 years to go to this goal.

At a 6% rate of return, the Rs 10 lakh Mr Rao has already invested would grow to about Rs 16 lakh in 8 years’ time. Should Mr Rao pass away today, Rs 14 lakh if his daughter’s education goal would remain unfunded. This should be added to his term cover requirement. Including this, his term cover need is now Rs 2.91 crore.  

Outstanding loans  

Having planned so meticulously to take care of your family’s lifestyle and goals, you would surely not want your family to be faced with unpaid loans on your behalf after your passing. This makes it important for you to include the outstanding portion of all your loans – home loan, vehicle, durable, personal and credit card loans – in your term cover requirement.

While estimating your outstanding dues, it is enough to have accurate estimates of large liabilities like your home or car loan. For smaller loans such as personal loans or credit card debt, you can use a ballpark estimate of the likely dues.

This will ensure that part of insurance pay out your family receives can be used to settle debts and start off with a clean slate. While estimating your outstanding dues, it is enough to have accurate estimates of large liabilities like your home or car loan. For smaller loans such as personal loans or credit card debt, you can use a ballpark estimate of the likely dues.

In the above illustration, let’s assume Mr Rao has a home loan outstanding of Rs 40 lakh and a car loan of Rs 5 lakh that he’s been repaying out of his income. This would jack up his term cover need by Rs 45 lakh.

But then, in the event of his demise, Mr Rao’s beneficiaries would probably stand to receive his provident fund dues and other payouts from his employer. They would also receive control of his investments and the cash in his bank accounts. These can be used to partly or fully settle Mr Rao’s debt. Therefore, these assets on Mr Rao’s balance sheet need to be netted out from his liabilities before assessing his term cover requirement.

Suppose Mr Rao had total PF and other savings of Rs 35 lakh to his credit (excluding his daughter’s college fund), his net dues after adjustments for assets would be Rs 10 lakh. Only this needs to be added to his term cover requirement. Overall, Mr Rao’s family would be well covered at a sum assured of about Rs 3 crore. This is the size of the term plan he needs to sign up for.

The above illustration also makes it clear that the quantum of term cover you need is not frozen in time. It needs to change with your life situation, number of dependants, income levels and liabilities.

Therefore, its not enough to buy a term insurance plan once in your life and pay premiums faithfully. You need to re-visit and add to your life insurance after significant life events, to ensure that you have enough cover to keep your family protected.


Also find out how LIC’s bonuses work – Bonus Rate of LIC

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26 thoughts on “How much life insurance do you need?”

  1. Respected Primeinvestor Team,

    My father is a government servant. He has one and a half years remaining for retiring.

    A Central Government servant has an option to commute a portion of pension, not exceeding 40% of it, into a lump sum payment.

    Considering at 60% commutation, it is 25Lakhs for him. And choosing a 60% commutation, he will get 25% less monthly pension with respect to forgoing commutation.

    Now he is thinking of forging commutation and go with a whole life term plan of 50L. As a monthly premium of this is 10% of monthly pension.

    I become independent. So he has not any financial liability or commitment. But he is thinking like a business mind.

    Please suggest that is it the right thing to do and also other options. If data are not sufficient to suggest please let me know.

  2. Thank you again for the article! My son is 18 now and we are thinking of getting him to Invest in small ways in MF say 2K per month as he gets into college now and take an insurance of Rs. 1 crore for 42 years. (Bank suggested longer and thankfully had read ur article then – will go for Online either through HDFC or ICICI Pru) . We are working middle class. Used the calculator but since most values are NIL, unable to decide. Can you pls guide?

  3. I have a question. Let’s say one person needs a life cover of Rs 5 cr based on the estimate you are suggesting. One takes 5 cr term insurance and gets sufficiently covered.

    Now, I will take an example to illustrate my point. And I have read your next article about “until what age should one take insurance” and this thought is not about what age but about what is the fault in the thought:
    Now next 2 cr term insurance for an adult age 36 is Rs 34579 (from one of the insuers, not mentioning the name as its not relevant) upto age of 100 (for 64 years term). Assuming one will not live beyond 100 and dies exactly at age of 100 and we think of this as some saving product where we are paying 34579 every year and getting 2 cr at the age of 100. The IRR comes at 5.5% and is tax free. Of course, if one dies before 100, the IRR will be much higher as premiums will stop and sum assured will be paid earlier.

    my question is what is the fault in this thought? Assumption is you are taking this as a investment product, (so you can comfortably pay the premiums till 63 years) with minimum after tax IRR of 5.5% with an upside if one dies before age of 100.

    1. Good question, sir. Your IRR calculation is quite correct. But there are three factors to consider. One, when investing you are looking to meet your own financial goals. In this case, it is your beneficiaries who will get this IRR and not you. Two, you will be locking into a product for 64 years and committing to pay premiums for 64 years just to get a 5.5% return. At this return you may not beat inflation in the long run, hich is the primary purpose of an investment. The rates may look today, at rock bottom interest rates but as rates improve you are likely to find superior returns with better liquidity. When evaluating any investment, returns, tax efficiency have to be traded off against liquidity which is exceedingly poor with term plans. Three, you cannot take the tax-free status for granted as tax laws can change substantially in the next 64 years.

  4. Hi,

    For what term of life we should take cover? Like nowadays, companies are offering whole life cover in term plan like cover upto 99 years. Here it is almost 100 pct sure that company have to pay the sum assured because of certain death. So, should we go for whole life cover in term plan given the fact that our family will definitely get the sum assured and with a very less investment amount.
    Pls advise.

    1. We plan to write on this next. The problem with whole life plan is that given the certainty of claim, the insurer substantially increases the premium. It may be better to take a term.cover for limited period and invest towards further family goals.

  5. अरुण कुंभार

    छान. अभ्यास केला… असेच लिहीत रहा..

  6. Very nicely put.. Considering the importance term insurance, such knowledge should be provided to users on selecting the coverage amount and years.. Informative article.. Hats off to the author..

  7. Vandhiadevan V

    If you provide any calculator to find the Sum is very much helpful by considering all the above input as parameters.

      1. Vandhiadevan V

        Thanks. One small clarification in your example Mr.Rao family calculated living expenses for 20 years from now with inflation added. Hope there should be additional corpus to take care of expenses after 20 years till the end of his spouse end age(life expectancy period). So the corpus will be much more and then the cover should be increased. Am i right ?

        1. Usually pure term cover is provided by insurers only for income replacement during your working years. Insurers maybnot accept lufe covers that are disproportionate to earning capacity. However if you want to provide for them you cannadd it into the term cover requirement and see if it is accepted.

      2. Hi,

        For what term of life we should take cover? Like nowadays, companies are offering whole life cover in term plan like cover upto 99 years. Here it is almost 100 pct sure that company have to pay the sum assured because of certain death. So, should we go for whole life cover in term plan given the fact that our family will definitely get the sum assured and with a very less investment amount.
        Pls advise.

    1. Excellent. Very Well explained.
      Suggest make it simpler like a b c d.
      The points to be followed.



      Good Morning Madam,
      I want to know whether I can buy term plan from two different insurance companies, for back up if any death occurs and any delay from one insurance company regarding claim at least one company may settle early and I would like to know within how many days they should settle the claim after submitting all documents and specially in the current covid situation,as you know the present mortality rates are higher,any data presently which insurance companies are more sympathetic towards the customer towards the claim settlement in today’s crisis.
      Thanking You,

      1. You can opt for two plans if you wish but this would force your beneficiaries to go thru two sets of formalities to file claims! We will be giving details of claim settlement ratios when we launch our insurance product shortly.

        1. I also noticed the Premium for a single 1.05 crore policy vs 3 x 35 lkh policies was cheaper . But can’t we assume we are spreading the risk heirs ? And is claim settlement ratios a good tool to measure policies when most of them are relatively young companies , and data could be misleading . Also over a period of 15 years wouldn’t their management style change to safeguard their shareholders then ?

          1. Must be because servicing costs for insurer are lower with a Single plan. Yes you are right on claims and we factor that into our to be launched ranking system

      2. Hi.
        You can buy Term plan from multiple insurer just remember you need to disclose all your policies and their Sum Assured and other policy details as required to the insuring company.

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