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The Long Read
Everything you *need to know* is right above this. Scroll down, only if you'd still like to read more (honestly, why?)
No. This is a popular rule of thumb that many people consider when calculating their life cover before buying a term insurance plan.
But remember, the math is overly simplistic.
This formula gives you a life cover amount that will enable you to cover your family only for 10 years after your death.
Is that enough?
Well, there is no guarantee that your children or anyone who was financially dependent on you when you were around, will be independent within 10 years of your passing away.
For example, if your children are 7 and 10 years old at time of your passing, in 10 years they will be 17 and 20 years i.e. they will still not be financially independent and your family needs to be able to afford their care and education, among other responsibilities.
Also, there’s no way of knowing for sure that this policy amount will help your family meet their financial responsibilities like everyday expenses, loan payment, child’s education, medical expenses and so on.
So do not go by this thumb rule when calculating your life cover, because it won’t help you provide your family with adequate financial protection in your absence.
Simple. Use this formula to calculate your life cover:
Life cover = Your Policy Term x Your Current Annual Income*
*It is the pre-tax annual income that you earn by actively working, aka the income that’ll stop coming in if you’re not around. It includes your salary and business income but not any rental income, interest, and dividend.
That’s it. This is the only formula you need to calculate your life cover. You don’t need any other detailed life cover calculators for this.
You are underinsured if your term insurance life cover is not sufficient to meet your family’s expenses in the event of your untimely demise.
Use this simple formula to find out if you’re underinsured or not.
The additional life cover amount you need = Current annual income x Number of years for your retirement from now - Current cover
If this value is a positive number then you are underinsured.
If this value is a negative number, then you are over insured.
If it’s zero, then congratulations, you are adequately covered!
Let’s take an example.
Say at the age of 30, you have purchased a term insurance plan that covers you till the age of 60, aka your age of retirement. Your current annual income then was ₹ 10 lakhs and the life cover you got was ₹ 3 crores.
Now, say at the age of 45, you want to find out if you are adequately covered. Your current annual income is ₹ 30 lakhs.
The additional life cover amount you need = ₹ 30 lakhs * 15 - ₹ 3 crores = ₹ 1.5 crores
So you are underinsured by ₹ 1.5 crores.
Your untimely death can put your family in a financial crisis, especially if you were the sole breadwinner. In your absence your family will depend on your policy money to meet their expenses.
If you are underinsured, here’s what you can do to rectify this problem:
Check with your insurer if you can increase the life cover of your current plan
Buy an additional term insurance plan and increase your total life cover if your current policy doesn’t allow you to change your cover
While having more life cover than required sounds like a good idea, it’s not. Why? Because a higher life cover means you’ll be charged a significantly higher premium as well.
Remember, term insurance is not an investment. It is just a replacement of your income. You will not get any maturity benefit i.e. you will not get any financial return if you survive the policy duration.
So your life cover amount should just be the replacement of your income that your family won’t have access to in the event of your unexpected death, especially if you were the sole breadwinner.
Instead of paying higher premiums, you could invest the additional premium amount to get better returns and create more wealth for your family.
Simple, you should always opt for a term insurance plan with high cover and lower duration and not one with a low cover and higher duration.
Why? Let’s understand with an example:
Say you have two options:
A term policy with ₹ 3 crore cover till 60 years or
A term policy with ₹ 1 crore cover till 80 years
What do you choose?
The policy with ₹ 3 crore cover till 60 years because you will get more cover while staying covered till the right age.
The 2nd option may sound more lucrative because it covers you for longer and you will also pay a lesser premium because of a lower cover amount.
You’ll probably retire by 60-65 years
By then, you'll have met all your financial responsibilities
You are also likely to have acquired enough wealth
Your children will most probably be financially independent
The value of your ₹ 1 crore will be reduced due to inflation when your family gets it
Remember, when faced with two options for a term plan, always go with the one that offers a higher life cover for the right policy duration, instead of lower cover for a long policy duration.
No, you don’t need to use complex online calculators to know what life cover you need.
These calculators consider factors like your income, expenses, liabilities and other factors to calculate your life cover. However, they function more on standard assumptions than on actual facts. So their recommendation is not 100% accurate.
Instead of using complex calculators to find out your life cover, what you need is a broad calculation based on your income and policy duration.
You can instead, take the KlarifyLife Term Guide to easily calculate your life cover.
You should buy an individual term plan with a cover that is adequate to meet your family’s financial needs if you pass away. Relying just on group plans is not a great idea because:
They offer lower covers than individual term plans. A low life cover may not be adequate for protecting your family financially if you pass away.
There may be limited to no customisation options, for example, you may not be able to get add-on benefits like critical illness rider.
They may become inactive if you leave the organisation or take a sabbatical.
You should buy a term policy based on what your needs are. You can understand your term insurance needs by checking out the Term Guide.
Simple. Even if you don’t have many financial dependents, you don’t want them to be covered for only 10 years after your sudden demise, right? It’s not the number of dependents but it is their complete financial security that matters.
The rule of thumb just says your life cover should be 10x of your income; it's an oversimplification of life cover calculation and will cover your dependents only up to 10 years after your passing away.
And even if you don’t have many people depending on your income, that number may increase once you are married and/or have children and in-laws to look after. If you go by the rule of thumb, you will end up purchasing a term plan with inadequate cover.
Congrats on your high-paying job. Thanks to your job, you are also likely to have a robust investment plan to help you build a nest egg for your family.
All in all, it’s a great plan, but you will need to be alive to grow your investments. Life is unpredictable, so if you were to pass away unexpectedly, you will not have enough wealth accumulated for your family to stay financially secure in your absence. And inflation will also further reduce the value of this money. This is where your term plan comes in handy, as a backup for your financial plan.
But do you want to keep your loved ones covered only for 10 years? No, right?
Hence the rule of thumb is not the right formula to use to determine your life cover as the amount you’ll get will not be enough for your family.
Grow your wealth with investments thanks to your job but don’t forget to get a term plan with adequate life cover as a financial protection tool for your family.