Deciding whether you should buy term insurance or not is an easy decision. But, deciding the right sum assured for the policy can be challenging. Read on to know how to choose the right sum assured.
When you purchase a term life insurance policy, it is critical that you choose the right sum assured. It is the amount that your family member (or the appointed nominee) receives from the insurance company in the event of your unfortunate demise before the end of the policy term. Before you sign the policy papers, it is paramount that you take your time to assess your financial standing and decide the sum assured accordingly.
You must bear in mind your current income, the number of people who are financially dependent on you, the current income, etc. All these factors help in deciding the sum assured. A lower sum would mean that your family will have insufficient funds to cover their expenses and they face the risk of suffering financial hardships.
If you are not sure how to decide the right sum assured for a term insurance plan, many experts recommend following the rule of thumb – the sum assured must be at least 15-20 times more than the yearly income you are earning currently.
The sum assured of the term policy must serve the following purposes to your family members –
- In the absence of the primary breadwinner in the family, the amount received must serve as an income replacement.
- It should cover the debts and outstanding payments you may have, such as home loan, business loan, credit card bills, etc.
- The amount received must be enough to support the family’s finances and help them be independent without compromising on their usual lifestyle.
- It should provide theme enough financial assistance so that your family can accomplish their financial goals.
Now that you know the importance of selecting the right sum assured for your term insurance policy, it would help to understand the steps for choosing the right sum assured amount.
Firstly, count the number of years you are expected to be earning. Since a term life insurance policy serves as an income replacement for the family, the years of income it must replace will have a significant impact on the sum assured. For example, let us assume you are currently 30 years old, and wish to retire at 60, then you still have 30 earning years ahead of you, which means the sum assured must provide income replacement for 30 years.
Once you are sure of the earning ears, the next step is to assess the family expenses. You must consider all the current and future expenses like home loan, medical costs, utility bills, etc. The term insurance policy must cover all these expenses on a yearly basis. Now, plot the expenses against the value of the investments and savings to assess how much financial safety you need and choose the sum assured accordingly.
Prepare a list of various important events where your family may need a lumpsum amount or incur a heavy expense. This could be child marriage, child higher education, medical emergency, etc. if you are already savings for such events through other investments, you can add the expected returns to the cash flow and decide the term insurance sum assured accordingly.
List down all the liabilities that you may have, such as home loan, credit card bills, personal loan, etc. and add the amount to the expenses as drawn in the above steps. Now subtract the value of the life insurance and the value of other investments (if any) from the figure. The final amount you get must be your ideal sum assured for the term insurance policy.
Choosing the right sum assured requires careful planning and meticulous calculation. So, do your due diligence and choose the right amount so that your family can easily meet their future expenses.