The concept of a life insurance policy, wherein a designated beneficiary is paid a sum of money in the event of natural death of the policy holder, is often misunderstood, say financial experts. Every year, many individuals end up subscribing to unsuitable policies simply because they make a hurried decision days ahead of the income tax filing deadline, they say. Some life insurance policies serve the dual purpose of providing protection as well as return on investment. Bad decisions - when it comes to insurance policy selection - often fail to serve the goal, they add.
- Entire amount paid as premium can't be claimed for income tax deduction
- Deduction limited to 10% of sum assured for policies issued after 2012
- Choose an easily payable premium considering liabilities, say experts
Here are 10 basic things you must consider before putting your money in a life insurance policy:
The premium should be easily payable considering one's regular liabilities such as EMI, rent, household expense etc. One should avoid stretching his or her premium paying ability while making a decision, say experts.
"Discontinuing a policy midway can lead to losses. Buy a policy that you can afford and will be able to continue without impinging on other financial commitments," said Jaideep Devare, MD and CEO, Mahindra Insurance Brokers Limited.
"A person must keep in mind his premium paying ability, purpose of investment, term of insurance, risk covered by the policy, etc. before buying an insurance policy," said Ashok Shah, partner, N.A. Shah Associates LLP.
Many life insurance subscribers mistakenly assume that the entire premium paid can be claimed as income tax deduction. This is not true. Deduction is restricted to 20 per cent of capital sum assured in respect of policies issued on or before March 31, 2012 and 10 per cent in case of policies issued on or after April 1, 2012, according the Income Tax Department.
"One should have a cover of at least 5-6 times the annual income. Buy an endowment insurance plan or a ULIP (Unit Linked Insurance Plans) only if you already have adequate life cover," said Mr Devare of Mahindra Insurance Brokers.
ULIP combines the benefits of life insurance policy with those of mutual funds. A certain part of the premium is invested in equities or equity-related funds; the remainder is used as premium for life insurance. Subscribers can pay a premium monthly or annually.
A term life insurance plan is usually purchased on an annual renewable term (ART) basis. That means the policy is renewed every year for a period of one year. The term can vary in case of an endowment plan, which offers the combined benefit of insurance and investment. Experts say one must be clear about the term before committing to a policy.
"Term insurance has the most affordable premiums across all life insurance policies and covers the nominees for the duration of the policy without any changes in the premium," said Sanjay Tiwari, executive vice president, product management, Exide Life Insurance.
4. Risk covered
"One must also closely observe the sum assured, benefits provided, risks covered, flexibility offered, premium amount, etc. It is also advisable to compare the policies offered by various insurers before finalizing a choice," said Mr Shah.
5. Additional benefits
Term insurance plans are suitable for individuals seeking complete risk cover against liabilities. Compared with term insurance plans, endowment and ULIP plans usually offer additional benefits at a higher premium at lower insurance cover.
"While a mix of both plans (term insurance plan and endowment insurance plan) can strengthen your financial planning for the future, it is extremely critical to own either one right at the start of your career," said Mr Tiwari.
6. Sum assured
In term insurance, the entire premium paid by the subscriber is utilized towards life cover. That means that the assured sum is paid to the designated person only if death occurs, under certain pre-defined conditions, while the policy is valid. If the insured survives the term, no amount is received either by the policy holder or the beneficiary.
While term policies are renewed every year, an endowment plan can be converted into a paid-up plan wherein the subscriber no longer pays the premium. The sum assured, however, is reduced.
That is why one must ask the insurance agent about the sum assured in case of any confusion about the policy, say experts.
"For covering liabilities like a home loan, it is advisable to opt for a term insurance plan... For example for age 35 years to cover a liability of Rs. 50 lakh, the annual premium payable would be approximately Rs. 9,000 for a term of 30 years. For covering a monthly income of Rs. 50,000 for 25 years (till age 60 of life assured), the annual premium of Rs. 12,000 would be payable (premium for a healthy, non-smoker male excluding GST)," said Khalid Ahmad, products head, PNB MetLife.
7. Claim settlement record of the insurer
"Buying a life insurance is a long-term commitment and hence the decision to buy a life Insurance policy must follow a thorough understanding of the product along with information about the experience of the life insurance company," said Mr Tiwari of Exide Life Insurance.
ULIPs are market-linked plans, meaning they come with market-related risks. Other than term plans, individuals must learn about the return on their investment, say experts. "Traditional insurance plans do not yield more than 6-7 per cent returns while ULIPs carry market risk. Be prepared for low returns from traditional plans and downside risk in ULIPs," said Mr Devare of Mahindra Insurance Brokers.
From an investment point of view, an individual must understand that it may be cheaper to invest directly in an equity mutual fund compared to a ULIP.
Though insurance regulator IRDA (Insurance Regulatory and Development Authority) has capped the charges, "insurance policies are costly compared to other investments such as mutual funds. Small savings and bank deposits have no charges," Mr Devare adds.
Selection of an insurance plan should also be based on the impact of inflation viz-a-viz the future needs of one's family, say experts. "One should also factor in rising inflation when deciding the amount of cover," explained Mr Ahmad of PNB MetLife.