In general, the ideal life insurance policy amount can be calculated by considering your long-term financial obligations.
Need for life insurance: The universal rule is that if you have a family that depends on you financially, you certainly need life insurance. “If you happen to be the only employed person in your family and are maintaining your family’s current lifestyle, taking care of the spouse and repaying debts, you need to have a life insurance policy to maintain their quality of life for the foreseeable future,” said Sajja Praveen Chowdary, head – term life insurance, Policybazaar.com. “A dependent could be your spouse, children or elderly parents or any relative who depends on you financially,” Chowdary added.
The DIME formula: DIME, which stands for debt, income, mortgage and education, is a formula that can take care of an individual’s specific insurance needs by taking a detailed look at his/her finances.
Debt, income, mortgage and education are the primary areas you should consider while calculating your life insurance needs. The fundamental objective of using the formula is to ensure that insurance coverage is adequate to provide for the needs of dependents in case of the early death of the sole breadwinner.
Parag Raja, managing director and chief executive officer, Bharti AXA Life Insurance, said it is vital to consider DIME and buy life insurance, as the claim money can help replace the breadwinner’s income, and enable the family to meet day-to-day expenses and maintain the lifestyle even if it will not replace the loss of the person.
“The claim money can help pay off existing loans (home, car and more) and outstanding debt. The money can also help pay for pre-empted future costs such as educational expenses of children. Owing to the customers’ evolving needs amid the pandemic, it is prudent to select a protection cover that includes a large life cover,” said Raja.
Outstanding debts: It is important to consider how much debt would you leave behind upon your death. Outstanding debts can be damaging to your family’s livelihood if they are not properly accounted for.
“If you have substantial debt, be sure to include it into your life insurance calculation so that your family has enough coverage to pay your debts off. For instance, you can start by adding all your debts such as car loan (say about ₹15 lakh) and home loan (say about ₹1 crore). In the given scenario, your family would be left with a debt of ₹1.15 crore upon your demise. Considering this amount, you would need life insurance with at least ₹1.5 crore sum assured to repay debts and maintain the property,” said Chowdary.
Income evaluation: One of the most significant needs for life insurance is income replacement. The next step is evaluating your annual income by simply calculating how much money your family needs to sustain the current standard of living. This is extremely important when you have a non-working spouse and children who are entirely dependent on your income.
Based on your earnings, and your family’s needs, you can figure out the number of years your family might need financial support in your absence and multiply your yearly income by the number.
Mortgage calculation: Another reason that necessitates the purchase of life insurance is having enough money to securely keep your family in your home. While buying a house, it’s common to sign up for a 20 or 30 years’ mortgage.
However, if you die before paying your mortgage loan fully, your life insurance policy should pay off the balance of your mortgage loan.
Churchil Bhatt, executive vice-president, debt investments, Kotak Mahindra Life Insurance, said, “Home loan equated monthly instalments generally leave a large dependency on the borrower’s future income. If you take a large home loan, it is best to take an insurance cover. In the case of existing life insurance, the life cover may be increased to include the loan amount. This way, it will ensure that your family is not burdened with unaffordable debt if something happens to you. The additional cover amount may be adjusted periodically to match the outstanding principal amount of the residual home loan to optimize premium.”
Education estimation: For the last step, add up the estimated amount of education cost that would be needed to send your children to college for higher studies.
You will need to consider buying life insurance that would cover some or all of their graduations costs.
“Aim to have a death benefit that includes fees, room rent and books. So, you should budget a minimum of ₹20 lakh per child for a four-year university education,” said Chowdary.
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