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News & Views

Wednesday, Mar 14, 2018

Don't buy term insurance just to save tax, make sure it is the right cover for you

[Source : The Economic Times]

To err is human, but making a financial mistake can come back to bite you when you least expect it. One such financial mistake made by people is that in their hurry to make last minute tax-saving investments, they miscalculate their insurance needs and overlooking getting a risk cover. People end up buying a life insurance policy just to avail the tax benefit that premium payments can fetch them, without considering their insurance needs.

Premiums paid towards a term insurance plan qualify for a tax benefit under section 80C of the Income- tax Act, 1961. You can claim a deduction up to Rs 1.5 lakh a financial year for the premium paid for yourself, your spouse, and your children.

But the tax benefit should not be the only factor to consider while buying an insurance plan. A term insurance plan acts as an income replacement tool for a family when the primary earner dies. The importance of having a term insurance plan is such that even financial planners suggest taking a life cover even before starting to invest for long-term goals.

Premium of a term insurance plan

All life insurance companies have term insurance plans. As term insurance plans do not have any maturity or surrender value, a buyer would more likely go with the plan that offers the lowest premium, at constant parameters such as age, term and sum assured.

And, as the premium of a term insurance plan is low compared to endowments or unit-linked insurance plans (Ulips), one may get influenced by its pricing and base the buying decision solely on the premium of the plan. However, while looking around for a term insurance plan, premium should be the last thing to look at.

If the term insurance plan has been bought with an adequate sum assured (life cover) and for the right tenure, it will help the surviving family members maintain same standard of living when the breadwinner dies.

So, to save on tax or pay a low premium, don't just buy any term plan without reading the terms and conditions. Here are a few important things one should consider while picking a term plan.

1. When to buy

It's a misconception that only married people need insurance. In fact, life insurance is a necessity for anyone who has financial dependants. So, even unmarried children where parents are dependent on them need to have adequate life cover. In addition to the basic life insurance amount, one needs to add cover as and when liabilities increase. Add cover when there is new addition to the family or when a big-ticket loan such as home loan is taken.

2. How much you need

This is one of the most important factors in the buying process. For arriving at a more realistic figure, use any of the tools available on the insurer's website or on the Internet to arrive at how much cover you need to take. Most such tools base the calculations on the 'income' that one earns rather than on the 'expenses', and due to this figures will vary. As a thumb rule, you could buy a life cover equal to at least 10 times your annual income.

3. Will one plan be sufficient?

Ideally, one single term insurance plan should be enough. However, your insurance needs are not constant all throughout your life. The requirement starts increasing once you get married, have kids and start taking loans. But once the goals such as children education, marriage are met, the requirement starts tapering. Typically, by age 60 or on retirement, most individuals are over with their financial obligations.

There are many who are unsure about their future liabilities or haven't planned them yet. One may, therefore, split the total amount of cover into one or more policies. As and when one's liabilities are over, one may drop one plan by stopping to pay its premium. Buying a separate cover for liabilities, such as a home loan, helps and can be terminated when the loan is over.

Make sure your plans don't run long because post retirement, when earnings stop and you don't have any financial liabilities left to achieve, you may still have to keep paying premiums. As a fair practice, you should disclose the details of existing plans while buying a new policy from another insurer.

4. Should a rider be added

Merely having a life cover may not be enough. A policyholder may become disabled due to an accident or otherwise, thus impacting his or her earning capacity. Failure of making timely premium payments towards the policy may render it inoperative and the objective of buying the policy will not be met. Also, there may be hospital-related costs during the tenure of the policy. Invoking the base policy may not help or may not even be allowed. And, what if one wants to enhance the coverage in an existing plan at a lower cost? This is where riders of in a life insurance plan may come handy.

Riders are additional benefits in a life insurance policy and are optional. They may or may not be attached to the primary policy. When attached, they come into play on the occurrence of a specific event and provide a financial cover over and above the basic sum assured.

Few common riders are - Accidental Death Benefit, Accident and Accident Disability Benefit, Waiver of Premium, Income Benefit on Accidental Disability, Critical Illness, and Guaranteed Insurability Option.

Adding a rider may help you customise your life insurance policy. For those who want to keep risk covers in one place or with a single insurer, such benefits are useful. One may explore such benefits from non-life insurance companies too in terms of features and premium. However, evaluate the need of each specific rider rather than opting for them merely because of low premiums.

5. Tenure

The next important factor is to fix the tenure. Few insurers offer terms up to 35 or even 40 years. Longer the tenure mean's higher premium and vice versa. Also, insuring for a longer tenure may not be the right approach if your liabilities are over early or by the time you retire.

6. Type of plan

In addition to a plain vanilla term insurance policy, insures have started offering term plans that come with increasing and decreasing sum assured and few other options. Unless, one is able to review one's needs every five years and take corrective action, a plain vanilla, with the lowest premium, will be sufficient.

7. Offline or online

Other than an insurance agent, one can buy term plans directly from insurance companies by visiting their websites or from policy aggregator websites such as Policybazaar and Coverfox.

Buying a term insurance plam online has two benefits. One, the plan costs much lower cost online than its offline version. A term plan bought online can be cheaper by 25 percent or more than its offline version from the same insurer. Two, comparing features, price and availability of the policies is easier.

However, while buying a policy online do keep in mind that since there's no intermediary, all communication has to be done directly with the insurer.

8. Which insurer

All insurance companies are regulated by the Insurance Regulatory Authority of India (IRDAI), who not only keeps a close watch on their financials but also on their solvency margin, i.e., the ability to pay up the dues when they arise.

Insurance being long-term contracts, merely looking at the claims settlement ratio of an insurer may not help much as it will keep changing over the years. Do not buy a term plan from a company which you are not confident about, irrespective of the sales pitch and the low premium.

9. Filling of form

Insist on filling up the application form on your own rather than have the insurance agent do it. This makes you aware of the things the insurer wants to know before they underwrite the insurance cover to you. Ensure that you disclose all material information such as existing ailments and current medication, family history, your smoking habits etc.

10. Nomination

Do not leave filling up the nomination for the policy for later. Further, your nominees must be aware of the insurance cover you are about to buy and should know where the policy documents are kept. One way to make sure the proceeds go to the intended beneficiaries is when the insured endorses the policy under the Married Women's Property Act, 1874 (MWP).

What you should do

Having bought a protection plan, make sure you top it up with a critical illness or a disease specific plan such as a cancer cover. Buying life insurance merely to save tax could be financially damaging. Instead, park your savings in Public Provident Fund or Equity Linked Savings Scheme for meeting long-term goals, while keeping the tax liability at bay. And keep these factors in mind while selecting a term plan.

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