Term Insurance Calculator

How do you choose the right term insurance coverage?

This article will explain how to choose the right term cover for your profile, the different methods available to compute this figure and which method you should consider.

What is Term Insurance?

A term cover is an extension of a very simple idea. What amount of money should your family receive in your absence? If you think 1 Crore fits the bill, then you buy a term insurance policy with a cover totaling 1 Crores. In your absence the family will receive this sum tax free.

However, choosing the right cover can be particularly challenging since different financial advisors swear by different methods. However, we won’t inundate you with complicated formulae. Instead we will use a few simple calculations to arrive at a figure that should do the job.

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Ideal Coverage for Term Insurance Plans

Before we do that, we need to bust a quick myth on using a popular thumb rule i.e. Many people say that you can choose your cover by simply assigning a multiple to your current annual income. So if you were making 12 lakhs an annum then you can simply multiply that number by 10 and buy a term policy with a cover totalling 1.2 crores i.e. 10 x 12 lakhs.

This is very easy to do. Unfortunately, it’s not a very robust way to calculate the cover.

Why?

Well, perhaps the problem can be best illustrated by using the example below,

In order to calculate the term insurance coverage, let’s take the example of Rahul who is currently 26 and earning ₹12 Lakhs per annum. And his situation is very dynamic. He wants to get married next year, buy a house and even have kids soon after. He also knows that to cover these expenses, he needs quick promotions. He needs to double his salary over the next 2-3 years. And he will have to change his lifestyle considerably.

While his expenses today are fairly limited, they could rise at least 5 times by the time he turns 30. And while his dependents include his parents who need a mere ₹1.5 lakhs every year, he will have a spouse and a newborn by the age of 30. Together his dependents will need ₹15 lakhs when he turns 30.

So in the event of Rahul’s passing at the age of 30, his family will need ₹15 Lakhs per annum at the bare minimum. They may need even more as Rahul’s kids grow up. Unfortunately none of these details are captured using the thumb rule method. It doesn’t capture his changing lifestyle. It doesn’t capture his rapid increase in income. Nor the change in dependents. So it falls short in many ways.

Ideally what Rahul should be doing is this. At the age of 26, he should be projecting his future expenses. Now this isn’t easy to do and it won't always be super accurate. But it will give Rahul an estimate. Once you project the expenses into the future, you can see how much money Rahul’s family (and his dependents) will need in his absence.

At this point you ask yourself one simple question.

If Rahul’s family gets ₹1.2 Crores at the age of 30 (cover calculated using thumb rule). Then how many years can they sustain without Rahul?

Well, let’s see that shall we?

After 8 years, they will run out of money. However, If Rahul were alive, then he would have supported the family until retirement. Not just for 8 years. So in reality the thumb rule method falls short of protecting Rahul’s family’s needs. We now know that the family needs much more than ₹1.5 Crores.

But how much?

Well, to figure out what kind of money the family will actually get with term insurance, here’s what you do.

First you project his family’s expenses until 60. I’ve assumed that the expenses will rise with an inflation rate of 5%. And I have added a buffer in the beginning to account for any miscellaneous expenses that may crop up in the future i.e. expenses Rahul may have to incur as his kids keep growing older. I also know that Rahul would have retired by 60 during which time his children would be independent and his retirement savings–substantial. This means by 60, his spouse would have ample funds to tide over the rest of her life even in his absence.

So if Rahul wanted to cover his family’s expenses until 60, he would need ₹4.6 Crores. This is illustrated in the figure below.

And this would ensure his family would always have enough money in the bank to manage their lifestyle irrespective of what happens to Rahul.

This is called the expense replacement method. And it’s a much better way to calculate the ideal cover. You can also do the same thing with income. Instead of projecting your expenses into the future. You can project your income until retirement and see what cover you need.

And both methods underscore the same idea. You have to create a financial replica of yourself. And this financial replica should provide the same cashflows that you would have extended to your dependents if you were alive. Once you do that, the term cover should take care of your family’s needs.

Just be sure to account for all future expenses and you should be good to go.

Note: Insurance companies may not always extend the cover you need because they have their guidelines on how to calculate the total cover. Please speak to our advisors to get a better understanding of how this actually works.