Money
Guide to buying term insurance: Keep it as simple as possible, but no simpler
Summary
- Always remember these 5 rules before buying a term cover, besides factoring in inflation and considering large future expenses and investments
If you are a cricket buff like me, odds are high that you would be watching the T20 World Cup matches late at night. Do you know apart from waking up until late, what else do I not like about this T20 World Cup? It’s the term plan advertisement aired on television between overs during every match.
The question asked in the advertisement is what should be the minimum term insurance coverage that you would need. And pat comes the reply: “10 times your annual earnings." If you check on YouTube, many influencers suggest a minimum cover of 15-20 times annual income.
“Make things as simple as possible, but no simpler" is a quote often attributed to Albert Einstein. It’s often used to encourage making a subject easy to understand, but its should not be so easy that it would become meaningless. These advertisements are doing the same thing. They are simplifying it so much that it loses its significance.
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So, what should determine your term insurance cover? I would say, broadly three things: financial situation, family expenses and life goals.
However, you should also factor in inflation, besides considering large future expenses and investments such as your child’s education and parents’ healthcare needs.
If you are a perfectionist, you may use the human life value calculator that does this calculation in a much more organized and practical way. It may help you decide on the coverage amount.
However, for most people who are not that sophisticated, there should ideally be a good balance between how much you can afford and how much you need.
We should avoid extremes on both ends. Just because your income is low, you should not ignore or under-cover for a term plan. Similarly, just because your income is very high, you should not over-cover for a term plan.
Let me share an example to prove my point. If you are a bootstrapped startup founder, there is a high probability that you are drawing either no or a meagre salary from your business. If you draw only ₹50,000 per month ( ₹6 lakh in annual compensation), do you think 10 times of that, or just ₹60 lakh, will be enough to secure your family’s future? Probably not. So, you may have to go beyond that 10x rule here.
On the other hand, if you are the chief executive of the highest paying asset management company, drawing a ₹50 crore-plus annual salary, should you compulsorily take a term plan coverage of ₹500 crore?
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To sum up, I would say, the following five simple rules can be a good guide to begin with:
- A term plan is a must for the income earner of a family. This is especially true when you’re the sole breadwinner and there is no alternative income source. The only exception to this rule is that your assets exceed your financial liabilities. For instance, you have a college-bound child, a dependent spouse and no outstanding loans, but you have enough savings that can cover the child’s education costs, a house where the family can live, and dividend and rental income that can provide for your spouse’s and child’s needs..
- Decide your coverage amount based on your financial situation, your present and future family expenses and future goals such as buying a house, or funding your child’s education.
- Never forget to factor in the impact of inflation on your family’s requirements. If your current monthly expenses are, say, ₹50,000, at an average inflation rate of 6%, after 10 years the same will cost you about ₹90,000. Deciding a corpus on the basis of the current expenses can lead to a shortfall in the future..
- Don’t go to the extreme. Keep a balance between what you can afford and what you need. For instance, for a young professional with an education loan, buying a policy that covers the loan is adequate. Whereas, for young professionals who have no liabilities, a term insurance may not be required at all. Buying insurance purely out of fear is not a good decision.
- Start as soon as you get financial liabilities in life. Even when your spouse is earning but your income exceeds hers, buy enough cover that can make up for the shortfall so that you don’t have to compromise on the lifestyle you have built together.
The sixth, and probably the most important rule, is that don’t fall for oversimplified calculations.
Ankit Kanodia is founder of Smart Sync Services, a Sebi-registered investment advisory firm.
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