How Much Term Cover Do You Need?

Post the onset of COVID-19, there’s been a marked increase in interest in term plans. With each passing day, more investors are turning to pure term plans to build up a robust life coverage in their names, while giving so called ‘savings’ plans the wide berth. And yet, most people remain confused about the quantum of life cover that they really need to achieve through term insurance. Is 1 Crore sufficient? Or is even 3 Crore too little? Most advisors tend to push arbitrary figures without a proper calculation framework, and this does precious little to alleviate the confusion. Here’s a simple model to help you arrive at the optimal life cover for your needs, based on the three key determinants – namely, income replacement, goal protection, and liability coverage.

Income Replacement

The primary determinant of your term coverage requirement is your current, post-tax income. Although some Financial Planners use the ‘expense replacement’ method to arrive at the HLV (Human Live Value) figure, a more holistic approach would be to cover your base to the extent of a certain multiple of your current income, as that would also take into account the future savings pool that would have been created from your income. While there’s no binding rule with respect to the multiplier factor per se, most Financial Planners agree on a number lying between 5 and 20 times your current, post tax income. If your dependent spouse is also earning and has bright career prospects, even 5X your current income may be sufficient. If your dependent spouse is a non-earning person, aim for the upper end of the spectrum.

Goal Protection

The second element of your term coverage requirement would be “Goal Protection” or having enough insurance coverage in place to ensure that your sacrosanct financial goals that are contingent upon your earning and saving ability are met, even in case of an unforeseen eventuality. Goals such as your Child’s Education or Marriage – or for that matter, even half your Retirement Corpus (if you have a dependent spouse, their expenses will also have to be met through a retirement fund), need to be protected. Remember, Goal Protection plans are only effective when they are coupled with savings plans such as Systematic Investment Plans (SIP’s) that also build out a corpus for these goals parallelly. In arriving at a optimal Goal Protection cover amount, you should ideally consider the inflation adjusted, future value of your goal amounts, and then arrive at their “present values” by discounting them with a reasonable expected rate of return of say, 10%. A professional Financial Planner can assist you with this, if you find it too challenging.

Liability Coverage

Have an outstanding home loan or a car loan? You need to ensure this is factored into your term coverage calculation too. In most instances, the family’s ability to clear the hefty EMIs associated with a home or car purchase hinges upon the continuity of income from the primary breadwinner’s side. For covering your liabilities, a decreasing term cover insurance works best. In a decreasing term insurance plan, you pay a constant premium every year, but the quantum of cover reduces year on year. After all, your outstanding liability will reduce with each passing year too, so why pay for something that you don’t need by taking up a term plan with a constant cover throughout? In exchange for the reducing cover, you’ll receive a substantial reduction in your annual premium amount.