How much term insurance do you need? Experts explain the right way to calculate your cover

Buying term insurance is often reduced to a simple rule of thumb of opting for a cover worth 10 to 15 times your annual income. But that calculation can fall short once you factor in a home loan, children’s education, dependent parents, household expenses and the future financial needs of the family.

The right amount of cover depends not just on what you earn today, but also on the financial responsibilities your family would have to shoulder in your absence. Experts say the calculation should therefore account for future liabilities, existing assets and the length of time dependants may need financial support. This becomes particularly important as income, family responsibilities and financial goals change over the years.

Income multiple is only a starting point

A cover of 10 to 15 times annual income can provide a starting point, but it should not be treated as a universal formula. Vikas Gupta, chief product officer at ICICI Prudential Life Insurance, said term insurance should be viewed as replacing the financial future that a salary was expected to create for the family.

For instance, a person earning ₹15 lakh a year could arrive at a basic cover of ₹1.5 crore to ₹2.25 crore using the income-multiple approach. However, the actual requirement could be higher depending on the person’s liabilities and dependants.

Aditya Mall, appointed actuary at Generali Central Life Insurance, said a more practical approach is to calculate the income that needs to be replaced for dependants, add outstanding liabilities and future financial goals, and then subtract existing assets and insurance cover.

This means two people earning the same income may require very different levels of life cover depending on their financial responsibilities.

Home loans and children’s education can significantly raise the requirement

Outstanding loans should be included because the family may have to continue servicing them even after the policyholder’s death. A home loan can therefore materially increase the required insurance cover.

Children’s education and other long-term financial goals should also be included. Shruti Oke, SVP and head of product management at Tata AIA Life Insurance, said income replacement needs, outstanding liabilities and future financial commitments should form the basis of the assessment.

Inflation also needs to be considered, particularly for goals that are several years away. Gupta said people should not simply add a fixed 6% or 7% inflation rate to their current insurance requirement. Instead, they should consider the future cost of the specific goals the cover is intended to protect.

Mall said the cost of maintaining a household or funding a child’s education several years from now could be materially different from today’s cost. This is particularly relevant for younger policyholders who may have a longer protection horizon.

Existing savings and investments should also be considered while calculating the protection gap. These assets may reduce the amount of additional insurance required.

When should you increase your term insurance cover?

Buying a lower amount of cover early in one’s career does not necessarily mean the gap cannot be corrected later. As income and financial responsibilities rise, an individual can consider taking additional term insurance rather than replacing the original policy.

Gupta said protection can be built in layers at different stages of life, with each layer addressing new responsibilities. Marriage, childbirth, a home loan, a significant increase in income, responsibility for ageing parents or starting a business can all change the amount of cover required.

Oke said some policies also offer features such as Life Stage Benefits that allow policyholders to enhance their cover at milestones such as marriage, childbirth or home-loan disbursal, subject to the policy terms.

Experts recommend reviewing term insurance every three to five years, while also reassessing the cover whenever there is a major change in income, liabilities, dependants or long-term financial goals.

The key test is whether the existing cover would allow the family to continue meeting its financial commitments without the policyholder’s future income. If the financial structure of the family changes, the insurance requirement may need to change as well.