Are you among the ones who think that “Insurance” is the safest haven to invest, then read on…
The fact of the matter is, the terms Insurance and Investment are contradictory. The very nature of Life Insurance (or any other insurance) is to alleviate risk and the very nature of Investment is to take on a comfortable degree of risk to generate commensurate returns. However, lack of awareness, captivating advertising promising eternal happiness and eager Insurance agents’ aggressively promoting products with terminologies that defy our understanding have left us mystic eyed. We hope that when we sign that illustration pamphlet giving us that 6% and 10% return benchmark our actual returns would be somewhere in the middle to leave us satisfied with our decision.
The truth is that Insurance is not like an OTC(Over the counter) drug purchased based on the recommendation of an Insurance salesman (who by the way gets a commission for his recommendation). It is rather a “customized and prescribed for you solution” and should be done after a thorough evaluation of your needs by yourself or by an experienced financial advisor.
The first modification in our thought process should be to avoid keeping our Insurance purchase till the last minute to fill in our 80C tax benefit. The right purchase of Insurance involves a thorough analysis on your current status and lifestyle your future plans and obligations, financial safety of your dependants in your absence etc. While tax saving is an added benefit, the very purpose for buying insurance should be safeguarding yourself, your dependants and your assets against risk.
Insurance companies today offer a plethora of products to suit various needs. The sheer variety can be intimidating. But if you take a moment to understand you own needs then fitting the right product in would not be very difficult. Let us take a look at some of the types of Insurance that suit our various needs.
This is the purest and simplest form of Insurance. It provides a life cover for a fixed period of time at the lowest possible premium. If the Insured dies within that term, then his beneficiary gets the sum assured. However, if the Insured survives the term then there is no payout. Essentially they are pure protection plans and are highly beneficial for young people with dependants. Since in the early stages of your career, the assets you build up are low and there are dependants to take care of, a term insurance plan is a suitable option to provide for your dependants in your absence.
As far as insurance amount is concerned one size does not fit all. It is advisable to sit with a pen and paper and chalk out your needs while deciding the value of term insurance you would need. Take a stock of your current assets be it income, investments, real estate, gold etc. and then account for your monthly expenses, future obligations like child’s education, marriage etc, your current obligations like mortgages, personal loans etc. Take the help of am insurance advisor to arrive at a suitable value and purchase the right product at the lowest possible cost.
ULIPS – Read the fine print.
The SEBI-IRDA tiff has brought ULIPs into the forefront of controversy lately. Let’s take a look on the product which is aggressively marketed and generates maximum revenues for the Life Insurance Industry.
ULIP is an abbreviation for Unit Linked Insurance Policy. A ULIP is a life insurance policy which provides a combination of risk cover and investment. Since the investments are linked to the capital markets, their performances have a direct bearing on the performance of the ULIPs. The Investment Risk in a ULIP is bourne by the Investor. Depending on your risk appetite you can invest your money in equity, fixed income/bonds, money market or in a balanced fund. You have an option of switching between funds. Read “Understanding ULIPs” for a complete analysis of ULIPs.
Endowment & Money Back Plans
Endowment Insurance plans are designed for a fixed period which can range from 10 to 30 years. The face value along with bonus or guaranteed additions is made after the expiry of the fixed period to the Insured or to his beneficiary in case of the Insured’s dies before that period. For someone who is just starting off in life, has an assured income stream for a number of years and is not willing to assume investment risk which comes along with mutual funds, ulips etc endowment policies are good life stage planning options. But beware that that endowment policies are not transparent at all. Do not be mislead by some smooth talking agent into believing that which ULIPs have charges (just because they are declared); endowment policies do not have any charges at all! Remember there is no free lunch! A portion of the premium goes towards the insured’s death cover, another portion goes towards the administrative expenses of the insured and a third portion is invested by the insurance company on behalf of the policy holder.
The return on the investments is distributed as bonus annually by the policy holder. However this annual bonus is accumulated yearly and paid out only at the end of the term. Also note, that the bonus declared does not compound yearly and since the investments are made in relatively safe debt securities your over all return will rarely go beyond 5-6%. Money Back plans help you meet specific objectives such as children’s education, their marriage or any other specific event occurring at fixed intervals. Unlike endowment insurance plans where the maturity benefit is paid only at the end of the endowment period, a money back policy provides for period payments during the term of the policy. Take for e.g. A 20 year Money Back policy will pay 20% if the maturity amount each after 5, 10, 15 and 20 years and the balance of 40% and the accrued bonus if applicable is paid on the completion of the 20th year. An important feature of this type of policies is that in the event of death at any time within the policy term, the death claim comprises full sum assured without deducting any of the survival benefit amounts, which have already been paid. Similarly, the bonus is also calculated on the full sum assured.
Like in endowment policies, as the investment is not linked to the capital markets, the returns are guaranteed and there is no investment risk involved. However the rate of return is low compared to ULIPs as the investment is mostly in the debt market. The advantages offered are guaranteed returns and periodic liquidity in case of a money back plan. The guaranteed nature of the product helps in the life stage planning process. They are a costly option for life insurance compared to term. Compared to ULIPs they lack transparency and flexibility.
Things you should know
15 day free look period
All Insurance products come with an IRDA mandated 15 day free look period calculated from the date of policy receipt. If within this period you are not satisfied with the product you can contact the Insurance Company and are eligible for a full refund of the premium. Please read your policy documents for further details.
All life Insurance plans offer tax benefits under Section 80C and Section 10 (10D) of the Income Tax Act, 1961. Under Section 80C, premiums up to Rs. 1, 00,000 are allowed as a deduction from your taxable income each year. Under Section 10 (10D), the benefits you receive from this plan are exempt from tax, subject to mentioned exclusions. Please note that tax benefit under Section 10 (10D) is available only if the premium payable in any year is not more than 20% of Sum Assured.
In a nutshell,
- It is best to keep Insurance and Investments separate. Clubbing them together will not do justice to either of them.
- Avoid waiting till its March and tax planning time to make a hurried Insurance purchase. You may not have enough time to evaluate your needs and assess which product is best suited for you.
- Term insurance plans are ideal in most cases where protection of your family in the event of your death is the main goal. However the inherent assumption while taking a term plan versus other Insurance investment plans is that you will have the discipline to invest the differential premium (Ulip/Endowment premium – term premium) in different investment vehicles to generate adequate return. So if you are among those who do not wish to spend time researching other investment vehicles and have a specific objective such a children’s education/marriage or retirement in mind then ULIPs offer you good flexibility and returns to meet your objectives.