How much term insurance is good enough?

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Term insurance is a safety net which protects your dependents from drowning in the sea of bankruptcy. If in a family of five a single person is earning, the world could come crashing on them not just emotionally but financially as well. In such cases term insurance comes to the rescue of the family, as it can carry the dependency in the absence of sole earner. Term insurance takes care of the debt of the sole earner and daily chores for certain period. Thus importance of term insurance cannot be denied, however how much term insurance can be labeled sufficient? This is very important to understand and note because majority Indians ignore the term insurance fact entirely let alone the quantity necessary.

The basic equation in any term loan is higher payout amount equal to higher premium and vice versa. Therefore understanding the payout requirement is primarily essential, thereafter the premium payment can be structured. There is no specific formula to understand the payout requirement, as many experts suggest it is almost impossible to predict how much amount can be sufficient. The basic rule suggests that an amount equivalent to 10-12 times of your annual income should be sufficient. However the basic assumption undertaken here is no liabilities on the policyholder. Therefore limitations under basic rules are ignorance to the lifestyle costs and the amount of liabilities undertaken by the policyholder.

Approach

The next approach is financial analysis approach, which takes into consideration the actual need of the policy taker. The need includes liabilities of policy holder such as car loans, home loans, etc, along with fund requirement of dependents in accordance with their lifestyle. In addition to that this approach also give due regard to certain specific requirement such as marriage or education of children. By adopting this method, policyholder not only takes care of dependency but also certain special needs which may arise in near future. In order to analyze the requirement of money, it is essential to acknowledge age, dependents, liabilities and assets current or future if any. In addition to that amount required to sustain the lifestyle of dependent can be ascertained by projected monthly expenditure plus the inflation.

Another method to calculate the amount of term insurance is on the basis of value of human life. This is nothing but the money earning capacity of a human in his entire working span. This is method is similar to discounting cash flow system, where potential future income are extracted in today’s value by discounting them with current inflation rate. The outcome is present value of future earnings of an individual based on his earning capacity. This outcome however is exclusive of any self-maintenance charges or taxes or even the insurance premium. This method is also common in road accident compensation insurance claims. The plus point of this method is it gives nearly accurate figure of the total term insurance required after considering necessary inflation factor. However on the flip side, important factors such as incremental revenue or individual life span are totally ignored.

If above method ignores individual life span, this method calculates term insurance amount on the basis of age. This method is known as the ‘underwriters thumb rule’, where as per the age of policy taker the amount is determined, for example if age group of policy taker is between 20-30 then the term insurance shall be 15 times their annual income. Following table explains the underwriters thumb rule.

Age	Multiples of annual income
20-30	15
31-40	14
41-45	12
46-50	10
51-55	8
56 & above	6

As seen above as the age limit grows the multiples decreases and eventually the term insurance amount. This is because the number of dependents decreases through employment or death. However one may wonder is term insurance really necessary above 56? The answer is yes, and the reason is protection, wealth maintenance and retirement.

A necessity

Protection is obviously against disability or death; this will result into loss of major earner in the family. Therefore, term insurance along with accidental death benefit, premium waiver or illness benefits is necessity. Once you are into your fifties, the age of retirement is nearby and the sources of income gradually decreases, wealth maintenance is that part which helps first time policy taker with lower premiums amount, single premium schemes or even pension schemes along with life cover. The reason to avail such thing is because of at the age of 50 and above the money retaining is important more than planning for future. And lastly retirement where time has arrived to reap the benefits of the efforts taken earlier. In this case generally your spouse and your parents are the only dependents, and it is essential to have a stable and continuous source of income.

There are various ways to determine how much term insurance is essential. However, none is future-proof, due to uncertainty. However, after taking into consideration of factors such as dependents, lifestyle, age of policy taker, earning capacity etc, one must choose the most appropriate method which satisfies his/her needs.

(The writer is founder, Money Mantra. Views expressed are personal)