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Home / Opinion / Income replacement term plans should be embraced

On one of the rare occasions when my wife took interest in our personal finances, I showed her our current life insurance term plan and told her about the amount (called sum assured in industry parlance) she would get if and when I kicked the bucket. With a rather deadpan look she answered: “That’s great but what should I do with the money; do I use a portion of that every month until it lasts or should it get invested somewhere so that we get a regular income?"

Going by our learnings from over 100,000 users on Bigdecisions.in, I can safely say that my wife is not an exception—there are lots more like her who find this whole area rather morose and therefore don’t spend too much time figuring it out.

That got me thinking about a rather different side of the problem.

Before we get much further, let us consider a typical single-income family of four people, with the insured being a 42-year-old gentleman with a 40-year-old non-earning spouse and two children (11-year-old son and 8-year-old daughter). The son wants to study to be an architect and his education expense is expected to be 50 lakh at current prices. The daughter wants to study medicine (expected expenses at current prices of 60 lakh). Further, the father wants to set aside an additional 25 lakh for the daughter’s wedding.

The family described in the example above has a monthly income of 1 lakh, which is essentially the insured person’s take-home income. The family supports itself with monthly expenses of around 75,000. It has no other source of income. The man has negligible risk cover from savings-cum-insurance policies which he purchased for tax-saving and is covered by his employer’s medical insurance scheme for health problems. His life insurance requirement is a sum assured of about 3 crore, which will help his family meet all their future expenses and liabilities.

However, this is where things get a little more complicated, and an interesting life insurance industry development is worth looking into. Decisions such as the amount of insurance and which product is most suitable assume that the person getting the money will know what to do with the lump sum she will receive upon death of the product buyer. Now, what happens if she doesn’t know what to do with the money (like my wife) or those who are not sure of where to invest the proceeds, do not entirely trust people close to the family and do not have access to trustworthy advice—as is quite often the case with many people in India.

A new variant that some life insurance companies have launched is worth taking a closer look. In these products, there is a feature of getting a lump sum upon the insured’s death and then a certain amount every month.

In the case of a regular term product, the entire amount is paid out as a lump sum to the beneficiary. The beneficiary then needs to invest the amount to get a regular income. This may not be a wise option for those who are not financially savvy. Based on the above example, the 3 crore would be paid out as a lump sum.

In the case of an income replacement product, a portion of the benefit is paid out as a lump sum to help tide over the immediate cash requirements and continues to pay a regular monthly income which increases with time. In the above example, it would be 1.2 crore paid out as a lump sum along with monthly payouts starting at 1.5 lakh per month.

These products break up the sum assured; so instead of paying 3 crore, as in the example above, the nominee will get a portion of that when the insured person dies and then a certain amount over a period of 10-15 years. The total amount the nominee receives over the period is higher than 3 crore.

Alternately, the lump sum amount may stay the same (again, staying with the 3 crore payout) with an additional amount paid to the family every month. In this case, of course the annual premium goes up but it might be worth the additional amount. Not so much because the return on money invested will be high, but because it’s likely that the nominee will already have lots to deal with at that time and may not be in a state of mind to deal with the prospect of having to figure out ways to maximize returns.

Manish Shah is co-founder and chief executive officer, Bigdecisions.in

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