Buy a life insurance policy and save up to Rs1 lakh under section 80C,” is perhaps the most common sales pitch around this time of the year. And why not? With life insurance striking the right chord between fear, guilt and greed, especially with the tax-saving deadline nearing, a lot of people readily give in to it.
While we agree that life insurance is a must-have financial product, we disagree with the way it is sold by agents. Despite the frenzy of reforms by the regulator last year, life insurance is still being pushed for all the wrong reasons: tax-saving, just savings and market-linked investments.
Also See | Plan For life (PDF)
So first principles first: Anyone having financial dependants needs insurance to ensure a secure financial future for them. But in order to serve its purpose, it is important to know how much insurance you need and which product will work best to achieve that.
How much you need
Your life insurance requirements keep changing along with your needs and life stage. Your age, number of dependants and lifestyle changes all need to be factored in while arriving at the sum assured, the amount that your beneficiary will get in case you die. For instance, the life insurance needs of an individual with dependant parents, kids and a home loan would be very different from one who only has a housewife as a dependant. Typically, individuals falling in the middle of their work life need more life insurance since responsibilities are maximum at this stage.
Says Sujata Dutta, senior vice-president and head (marketing and affinity sales channel), DLF Pramerica Life Insurance Co. Ltd: “Life insurance is meant to protect the income of the insured so that the dependants are protected. While we recommend customers to a sum assured anywhere between five-eight times their annual income, one needs to revisit their life insurance needs every four or five years.”
Young individuals without dependant parents or those nearing retirement may give insurance a miss. By that logic, any savings or investment plans that come with a life cover can be avoided. Other investment options such as the Public Provident Fund (PPF) and equity-linked savings scheme are better to save taxes.
Which product to buy
The life insurance industry will throw a plethora of options at you—from plain-vanilla term plans to hybrid plans that help you invest your money. But you need to pick the one that suits you the best.
Traditional versus term: Savings plans such as endowment and money-back have made a comeback. Since traditional plans invest your money largely in debt products and their cost structure is not transparent, we advise you to steer clear of these. Our discomfort is not just with the manner of investment alone, even insurance comes at a cost. For instance, a 30-year-old earning Rs10 lakh per annum should take a cover of around Rs50 lakh. In an endowment plan, the annual premium he will have to pay for a 20-year term would be around Rs2.33 lakh per annum. Compare this with a term plan—that offers only insurance and no investment—from the same insurer for the same cover and over the same period—around Rs11,643 per annum.
Unit-linked insurance plans (Ulips) versus term: Even Ulips that were the subject of a slew of reforms recently do not make it to the most preferred list of life insurance products. Here is why.
A high sum assured in a Ulip means higher mortality cost that will eat into your investments. The way Ulips are structured, they still have a short-term disadvantage in terms of insurance needs. To illustrate, a 30-year-old buys a type II Ulip (that pays the sum assured as well as the fund value as death benefit) for 30 years and opts for a sum assured of Rs15 lakh with an annual premium of Rs1 lakh. However, if the same individual invests Rs1 lakh in a combination of mutual funds and term plan, he will get an edge in a Ulip only after 10 years. Here’s how.
Let’s assume both Ulip and investments in a mutual fund grow at 10% and the term plan costs Rs3,165 per annum for the Rs15 lakh cover. If the investor dies in the 10th year, he will leave his nominee richer by about Rs19,000 if he opted for the term plan-MF combination over a Ulip. The earlier the investor dies, the richer will be his nominees compared with a Ulip holder.
Says Suresh Sadagopan, certified financial planner, Ladder7 Financial Advisories, a financial planning firm: “Ulips work only in the long term, but even if our clients have a long-term focus we don’t recommend Ulips because of the concentration risk. The entire corpus of the client is with one fund manager and we prefer our clients diversify across fund managers.” And since the cost in a Ulip is still front loaded, it works against you if you wish to change your fund manager, which means buying a new Ulip. Your only option is to change between funds available in the policy you are already into.
Why term: It is for these reasons that a term plan is our favourite in the bouquet of insurance products. The plan charges you only for the cost of insurance. So if you die during the term, your beneficiary gets the sum assured and if you outlive the term you get back nothing.
Term plans would continue to be attractive even when the rules of taxation get rewritten under the proposed direct taxes code, or DTC. Currently, the premium you pay on a life insurance policy qualifies for a deduction of up to Rs1 lakh under section 80C. However, under the proposed DTC, deduction up to Rs50,000 is available only if the sum assured that you choose is at least 20 times the annual premium you pay.
So in a Ulip, too, your sum assured would need to be at least 20 times the premiums you choose. However, DTC leaves much unsaid regarding the tax treatment on the maturity corpus of a Ulip. Ulips are getting better and it may work for investors looking to plug a minor shortfall in their life insurance need. However, keep in mind that Ulips work only when you have a horizon of at least 10 years.
Which term plan
Even in the category of term plans, there are variants to choose from.
Plain vanilla: The most basic is the level term insurance policy. You choose a sum assured and the insurer works out a premium you need to pay every year. The sum assured remains the same throughout the term and so does the premium. But not everybody likes the thought of paying for years together and not getting anything in return at the end.
Return of premium plans: In these, if you survive the term you get back all the premiums. These are slightly more expensive than a pure term plan. While they assuage the mindset that wants a return of money, it is not a good investment decision since the premium you pay does not earn interest.
Decreasing term plan: If you have a big-ticket mortgage such as a home loan, you could consider a decreasing term plan. The sum assured in this plan is equal to the loan amount. As your loan liability goes down over the years, so does your premium amount. The premiums on these plans are lower than that of a level term plan since every year the sum assured decreases.
Increasing term plan: Then there are increasing term plans that, typically, bump up your cover by 5% every year until your sum assured increases by 50% or doubles up in value. The premiums are higher as the insurer increases his liability every year.
Increasing plans take care of the worry of evaluating your insurance needs periodically, you must remember that they are very expensive and should be taken only when you are sure your assets will not suffice to provide for your family. It is better to revisit your insurance needs and bump up the cover if need be.
Online versions: Term plans have just become cheaper since they are now available on the online platform.
Insurance plans that are sold online do not have the intermediary cost and, hence, the premiums are lower. Currently, about four insurers are selling pure online term plans—Aegon Religare Life Insurance Co. Ltd sells iTerm, ICICI Prudential Life Insurance Co. Ltd sells iProtect, Kotak Life Insurance Co. Ltd sells e-Term and Future Generali Life Insurance Co. Ltd sells Smart Life policy.
While much of the process remains online, typically the know-your-client procedure goes offline. Additionally, you may need medical check-ups if you are opting for a higher sum insured or have medical problems.
This tax season buy appropriate life insurance cover after a detailed analysis of your needs. If you are already adequately insured, there are plenty of options to exhaust the 80C limit.
Graphic by Yogesh Kumar/Mint