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A person might find it confusing in determining the cover he/she requires. Purchasing insurance is important, but it is more important to properly calculate the cover amount that will be adequate for his/her family even if he/she is not around in the future. Just choosing any amount as sum assured may come to haunt the person’s family as an inadequate amount may simply ruin the whole purpose of purchasing insurance in the first place. The same is applicable if the person is looking to purchase a term insurance plan, and there are various methods through which he/she can determine the cover amount most suitable for him/her.
Income rule- This is the most basic rule which a person can follow while determining the cover amount adequate for him/her. The rule says that an individual’s cover amount should be 10-20 times his/her annual income. For example, if a person draws a salary of Rs.10 lakh annually, his/her cover amount must be in the range of Rs.1 crore to Rs.2 crore.
Income replacement value- A person can determine the coverage required based on his/her annual salary and the number of years left for him/her to retire. For example, if a person is 30 years old and draws a cheque for Rs.5 lakh p.a. and plans to retire 30 years later at the age of 60, the cover amount suitable for him/her can be: Annual Income x Number of years left for his/her retirement .i.e. Rs.5 lakh x 30 years which amounts to Rs.1.5 crore which will be the cover amount the person will need.
Premium as a percentage of annual salary- The rule says that 6% of the salary for basic needs + 1% per dependant member must be utilised as life insurance premiums. For example if the person’s annual income is Rs.5 lakh and he/she has a spouse and kid, the cover amount must be [Rs.41,000 x (.06 x 5,00,000 + 1 x 5,00,000 x 2)]. The sum total will be the total coverage required by the person.
Assets, liabilities and other events- Every individual has dreams that he/she wants to fulfill and hence he/she makes investments or take loans in order to achieve them. If a person has taken a loan and made investments, it will play a role in him/her determining the total coverage required. For example, if an individual has a home loan EMIs of Rs.40,000/month which will take him/her 10 years to clear, the numbers add up to be Rs.40,000 x 12 x 10, which is equal to Rs.48 lakh. If he/she made investments in various market tools, he/she can deduct the total amount from the total liabilities. For example, if the investment made by him/her amounts to Rs.8 lakh, he/she can deduct this amount from Rs.48 lakh which comes to a total of Rs.40 lakh which is the total liabilities a person will have to clear and hence can be the required coverage.
There are various other events that a person will have to take care of, for example taking care of his/her children’s education and marriage. If a person draws an income of Rs.5 lakh per annum and has 30 years before he/she retires, the adequate cover amount is Rs.1.5 crore. If we bring into account the liabilities that he/she will have to clear which as we know is Rs.40 lakh and supposing he/she will have to shell out Rs.15 lakh for his/her children’s education, then, in that case, the total cover amount he/she will need is Rs.1.5 crore + 40 lakh + 15 lakh which is a little over Rs.2 crore.
Annual gross earnings- This is one of the simplest means to calculate the cover required for an individual. He/she simply needs to multiply his/her annual salary with 12 (total number of months). For example, if an individual is earnings Rs.8 lakh p.a. his/her total cover amount must be Rs.8 lakh x 12 which is Rs.96 lakh.
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