Here we will discuss two common methods to calculate life insurance cover to ensure the same standard of living for your dependents. You can sit with a pen and paper to do the calculations.
Income replacement method
Multiply your annual income by the number of years you would want to provide for the financial needs of your family. You can subtract the amount of savings and investments from this sum if they are not aligned to any specific goals. This method simply aims to replace your income in your absence.
Here you can make note of your household expenses and your non-negotiable goals. You can then multiply your annual household expenses by the number of years you would want to provide for your loved ones. You can exclude any major expense that is incurred on yourself. You can also inflate your household expenditure to factor in the rise in expenses over the years.
Suppose your annual household expenditure is ₹5 lakh, you may not wish to remove the portion spent on yourself to take care of inflation. And if you want to provide for 10 years, you can simply multiply ₹5 lakh by 10 years that equals ₹50 lakh.
Next, you need to add outstanding loans like car loan, home loan, education loan to this amount. Suppose you have an outstanding car loan worth ₹7 lakh, add it to the earlier arrived figure. It totals to ₹57 lakh.
Add to this the value of your unavoidable goals. Suppose you have to pay for your child’s higher education worth ₹20 lakh, you can add this amount to the earlier figure of ₹57 lakh. The total sum now becomes ₹77 lakh.
From this amount, you can subtract your existing savings and investments. Suppose you have mutual fund investments worth ₹5 lakh, a second house worth ₹25 lakh and cash of ₹2 lakh.
Your calculation goes like: ₹77 lakh - ₹5 lakh - ₹25 lakh - ₹2 lakh = ₹45 lakh.
So, given the above illustration, you would need a life cover of ₹45 lakh to take care of financial needs of your family for 10 years.
This is not a fixed formula but it will help you to get an idea about your life insurance needs. You can also use human life value calculator to estimate your life cover. Most insurance companies have such calculators on their websites.
A general piece of advise is to be conservative while doing the calculations. A little higher cover will not hurt.