What's inside? 🧐
- Introduction
- What Is Sum Assured?
- What Is The Difference Between Sum Assured And Sum Insured ?
- Why Is Sum Assured Considered An Important Factor When It Comes To Term Insurance?
- How To Calculate The Sum Assured?
- But What About Inflation?
- To Conclude
Introduction
Life is full of surprises; some of them we expect, and others hit us out of the blue. Term insurance acts like a reliable guide for this journey, ensuring you have a clear direction even when your life gets tough. Just like a trusty map, term insurance lays out a plan for your financial well-being, especially in unexpected situations. With a term insurance policy, you will be able to protect your dear ones' financial future by taking care of things like mortgages, debts, or funding your children's education, even if you are not there to provide for them anymore.
When you talk about term insurance, one crucial aspect that often gets misunderstood or overlooked is the "sum assured." This term represents the sum of money your dear family receives in the event of your untimely demise during the policy term. And understanding the significance of the sum assured is vital in making informed decisions about your term insurance policy. Let's delve deeper into this concept to ensure you are well-equipped to make sound financial planning.
What Is Sum Assured?
Sum assured, a crucial term in term insurance, refers to the amount the insurance company commits to pay your nominee if you pass away during the policy's term. This ensures your family's financial stability in case of an unfortunate event. It acts as a safety net for your loved ones during difficult times.
In term insurance, the maximum sum assured you can obtain is determined by your income and age when purchasing the policy. Typically, this is calculated by multiplying your income by a specific factor, like 25X, 20X, or 15X, depending on your age. However, these factors may vary among insurance companies. And if you already hold a life insurance policy, the cover amount from that policy will be subtracted from the eligible term cover. This helps ensure that your overall insurance coverage aligns with your needs and financial circumstances.
Let's understand this better with an example –
Sonia is 25 years old and earns Rs. 12 Lakhs per year. She is considering getting a term plan from insurance company X. This company allows people aged 20 to 30 to get coverage up to 20 times their yearly income.
Based on this,
- The insurer's factor is 20X
- Sonia's annual income is Rs. 12 Lakhs
- Hence, the maximum coverage Sonia can choose is calculated as 20 times her income: 20 X 12 Lakhs = Rs. 2.4 Crores.
What Is The Difference Between Sum Assured And Sum Insured ?
Let’s understand the difference between these terms in term insurance -
| Sum Assured | Sum Insured |
| Sum assured is known as the guaranteed amount that will be paid out to beneficiaries if an insured passes away during the policy term, primarily seen in life insurance. | Sum insured represents the highest payout that the insurer will make for covered losses or damages within an insurance policy, commonly found in general insurance. |
| It is mainly associated with life insurance policies. | It is frequently tied to general insurance policies like health, property, or travel insurance. |
| The sum assured is calculated considering factors like the insured's age, income, lifestyle, and financial responsibilities. | You usually have the freedom to select the sum insured according to your needs and financial capacity, with some restrictions. |
| Typically, it remains constant throughout the policy term, though some policies may allow for adjustments or extra coverage. | Adjustments to the sum insured may be needed periodically to accommodate shifts in the value of insured property, inflation, or other pertinent factors. |
Why Is Sum Assured Considered An Important Factor When It Comes To Term Insurance?
Sum assured is a vital aspect in term insurance for several compelling reasons that include –
Ensuring Financial Security
The core objective of term insurance is to offer financial stability to your loved ones if you pass away unexpectedly. The sum assured represents the amount that will be disbursed to your chosen nominee if such an unfortunate event occurs. This ensures that your family can sustain their financial stability and lifestyle even after you are no longer there to provide for them.
Replacing Income
Ideally, the sum assured should be substantial enough to replace your income. It should encompass various aspects such as your family's day-to-day expenses, any outstanding debts, as well as future financial aspirations like your children's education or marriage expenses.
Accounting For Inflation
Sum assured is a crucial aspect of term insurance for various reasons. When determining the sum assured, it is vital to consider the impact of inflation. As time passes, the cost of living rises, and the purchasing power of money declines. A well-calculated sum assured takes inflation into account, ensuring that the payout retains its value and continues to fulfil your family's financial requirements.
Debt Settlement
Having sufficient sum assured is particularly important if you have outstanding loans or mortgages. In such cases, the sum assured can be utilised to settle these debts, alleviating the burden from your family. This prevents them from facing financial strain and ensures that they can maintain ownership of valuable assets like the family home, providing them with stability and peace of mind during difficult times.
Covering Future Expenses
The sum assured holds significant importance in term insurance for various reasons. It should be sufficient to cover future expenses like your children's education or significant life events. This ensures that your family can pursue their aspirations and goals even if you are no longer there to provide financial support.
Providing Peace Of Mind
Having an adequate sum assured in your term insurance policy offers you peace of mind. It gives you assurance that your loved ones will be financially safeguarded if something unexpected happens to you. By ensuring this financial stability, you fulfil your responsibility as the primary provider and protector of your family, offering them security and reassurance in uncertain times.
In essence, the sum assured in a term insurance plan plays a vital role in guarding your family's financial stability if something happens to you. It serves as a safety cushion, ensuring that your loved ones can uphold their lifestyle, cover expenses, and reach their financial objectives even without your support. Thus, it is crucial to thoughtfully evaluate your financial requirements and select an adequate sum assured when buying term insurance.
How To Calculate The Sum Assured?
Calculating the sum assured for your term insurance involves considering the financial support your family will need when you are no longer there. It is about bridging the gap between what you will leave behind and what your family truly requires to maintain their financial stability. To calculate this gap –
- Calculate the amount you owe
- Calculate the amount you own
- The required cover amount = Money you owe - Money you own
👉The Amount You Owe
The amount you owe includes the expenses your family will have to manage without the primary earner, covering both short-term everyday needs and long-term commitments. This can be differentiated into 3 main categories –
Daily Living Expenses
This fund is essential to create a reserve that generates regular income for your family's day-to-day necessities. Calculate it by totalling monthly and annual expenses like school fees, household help wages, rent, utilities, groceries, etc. Then, divide the total by the expected interest rate.
Future Aspirations
This fund covers major long-term expenses such as your spouse's education, your children's higher education, weddings, etc.
Outstanding Debts
Take stock of any loans or liabilities you have, as these will fall on your family to repay if you pass away. Sum up all loans, including home loans, personal loans, vehicle loans, joint loans, etc., to understand the total amount owed.
👉The Amount You Own
Calculating the amount you own might seem straightforward, but it is not as simple as adding up all your assets' values. This is because different assets come with varying degrees of liquidity and risk factors. To get an accurate picture, you need to adjust their values accordingly. Here's how –
Existing Life Insurance Covers @ 100%
Consider the value of your existing life insurance policies at 100%.
Savings, FDs & Cash @ 100%
These assets can be considered at their full value.
Equity Investments @ 50%
Take your equity shares and investments at half their total value to account for market fluctuations and risks.
Gold & Residential Property @ 0%
These assets are not easily liquidated for immediate expenses, so assign them zero value.
Stock Options @ 0%
Due to their high-risk nature, consider stock options at zero value. Any returns can be viewed as a bonus.
Totalling these adjustments gives you the actual amount you own. Then, you can calculate the total cover you need using the formula: Amount you own - amount you owe.
But What About Inflation?
When calculating your insurance needs, it is essential to consider inflation. For simplicity, the calculation provided assumes a scenario where death occurs today. However, to address inflationary concerns, we strongly recommend considering the increasing cover option offered by leading term life insurance plans.
This option ensures that your coverage grows systematically over time by a specified percentage until it reaches a maximum limit set by the insurer, effectively combating inflation. If you wish to factor in inflation for the entire policy term up front, multiply the cover amount by 2.5 to 3X to determine the inflation-proof coverage you require.
Alternatively, you can utilise MyInsureBuddy's Term TruMatch tool for a personalised term insurance coverage amount. Here, you have to answer a few straightforward questions regarding your current financial situation, long-term plans, and your family's goals. The TruMatch tool will process this information to provide you with a scientifically calculated coverage amount tailored to your family's needs. You will then receive a user-friendly PDF report to guide you in making the best decision for your family's financial security.
To Conclude!
Sum assured in term insurance is the guaranteed amount your dear ones receive if you pass away during the policy. It ensures their financial stability, covering expenses and future goals. Sum assured should ideally replace your income and account for inflation. It is essential to assess all your financial needs to choose an appropriate sum assured. In conclusion, sum assured safeguards your family's future, providing peace of mind during difficult times.
You also have the option to schedule a personalised 1-to-1 consultation to gain further insights into selecting the appropriate sum assured for your term insurance. Our team of financial advisors offers expert guidance and advice to ensure you make the best decision tailored to your needs.