Term insurance calculator

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? Most of you go for the nice round number suggested by your insurance agent, which is usually Rs 1 crore.

But your term insurance is unique to your life and family. A small number may leave your family under-prepared. At the other extreme, a large number will be a needless drain in premiums paid, since premiums aren’t returned to you in pure term plans.

Here’s how you actually arrive at the cover you need.

Step 1 – What is the income you need to replace?

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 don’t miss the money you were bringing home in the event of your death. So the first step is to estimate the monthly expenses your family or dependants need to maintain a reasonable standard of living in your absence.

First, reduce your personal 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 your term insurance plan. Second, 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.  

Illustration: Mr A 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 he was 50, he’d need less.

But the above calculation does not budget for inflation. To get to a realistic term cover, therefore, adjust your family’s expenses for inflation for the period for which they need income replacement.

In the above illustration, if Mr A 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.

Third, the number can be reduced if you expect any of your dependants to stop relying on you in future. In our illustration, suppose Mr A’s 10-year old daughter can be expected to become financially independent by the time she’s 25, Mr A 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.

Step 2: Meeting financial goals

Financial goals that you were hoping to fund with your future savings need to be funded by your term cover too.

Let’s assume Mr A was investing towards a Rs 30 lakh education fund for his daughter’s graduate and post graduate degrees when she turned 18. His early demise will leave this goal unfulfilled. So, this risk must be mitigated by adding in the unfunded portion of the education goal into the term cover.

Suppose Mr A had Rs 10 lakh already invested in the 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 the daughter 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 invested would grow to about Rs 16 lakh.

Should Mr A pass away today, Rs 14 lakh of 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.  

Step 3: Paying outstanding loans  

You would not want your family to be faced with unpaid loans on your behalf after your passing. It is 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.

 This will ensure that part of insurance pay out your family receives can be used to settle debts. 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 A has a home loan outstanding of Rs 40 lakh and a car loan of Rs 5 lakh. This would jack up his term cover need by Rs 45 lakh.

But then, in the event of his demise, Mr A’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 the debt. Therefore, these assets need to be netted out from the liabilities before assessing term cover requirement.

Suppose Mr A 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 A’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 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, it’s 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.