Determining the adequate risk coverage and suitable insurance products is an important aspect of financial planning. The various complexities attached with existing life insurance policies in the market make choosing the right one difficult. Listed below are the most common pitfalls one needs to avoid while buying a life insurance policy.
- Miscalculating insurance requirement: Determining the ideal amount of insurance cover needed is one of the most common insurance mistakes. One has to objectively address the question of: "How much Insurance cover do I need?" This can help the individuals in buying exactly what they need. Most of the times we end up being over-insured buying unnecessary insurance products or under-insured by failing to get required risk cover. Ideally, the risk coverage provided by the insurance policy should match the committed expenses of the individual for the years to come. One can also consider including the mandatory goals (retirement, child's marriage, etc.) while calculating the insurance requirements.
- Mixing insurance with investments: Considering insurance as an investment is another common mistake. It is a common misconception that insurance is a risk-free investment. One has to note that insurance and investments are two completely different financial entities. We buy insurance as a part of risk coverage which can be used in case of any unexpected eventuality of the earning member of the family. We make investments primarily to achieve our goals and build wealth. When we mix both these important financial entities, we fail to do justice to both. One has to pay higher premiums for the insurance policies which return the premium paid along with an interest after a stipulated time. So, the chances of getting adequate insurance cover paying such higher premiums are minimal. Even the returns one can enjoy on such insurance policies are significantly less than the money invested in a well-diversified portfolio.
- Insurance is the best way to save tax (primary motive of buying insurance): Insurance for long has been the front runner whenever investments regarding tax savings are considered. People often fail to realize that not all insurance payments are tax free. It is subjected to the upper limit of section 80C, which is caped at Rs 1 lakh. Essentially, the contributions made towards provident fund and principal repayments of a home loan are also considered under section 80C. One should consider insurance just as a risk mitigating financial instrument, tax saving is just an icing on the cake and not the primary motive of buying insurance. Under the common myth that every premium paid is eligible for tax saving, most of us end up buying unnecessary insurance products.
- Expecting returns from life insurance: For most of us, the whole perception of insurance changes when it has a prefix of life to it. For example, consider auto insurance. We pay a premium for our auto insurance which covers from the damages done to our vehicle in case of any mishap. We pay the premium every year, we enjoy no-claim bonuses if no claims are made and most importantly at the end of it, we do not receive any money back along with interest. The same fundamentals should be applied for life insurance as well. The main motto of a life insurance policy is to protect the family from the risk of mishap to the bread winner of the family. Our behavioral nature of wanting to get back something from the insurance premiums make us opt for insurance policies which are other than term policies. Term insurance can be availed at much lower cost compared to other hybrid insurance policies.
ArthaYantra is an integrated online personal finance company.
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