The reason for writing this article is because last week I came across a person who had no less than 25 life insurance policies. Yes, you read that right - 25.
Having multiple insurance polices never made practical or financial sense. Yet, I understand that there are people who may have even more. This happens because investors actually buy insurance policies for saving taxes. Each year, there is a new insurance policy and consequently, over time, the number of policies adds up.
It's not that I am against the concept of insurance. Life insurance is a necessity. However, it is not an investment. Make no mistake about this. There is no substitute for life cover, none whatsoever. It is the only means of providing security to your near and dear ones against your untimely death or to yourself against your old age. Therefore, the yield on investment per se is of lesser importance. The cover or protection overrides all other considerations. However, note that it is a necessity only if the demise of the bread winner of the family will put immense financial pressure on the family members left behind.
However, if that is not the case, you must reconsider your options. Every product has an associated cost attached to it and so does insurance.
Don't buy a product you don't need. Excessive insurance injures financial health. So, never buy an insurance product with the sole purpose of saving tax. That would be like meeting a short-term liability with a long-term obligation. The tax payable is your short-term obligation that you have to fulfil for that particular year. However, insurance products are of a long-term nature and you may find that though you may have saved the tax for that particular year, you will be paying for it by way of future premiums for many years to come. A better way to save tax would be to make use of ELSS funds or if you are risk averse, instruments such as PPF or post office deposits.
Term insurance
If you indeed need insurance, buy it once for all. Perhaps one of the best products of the insurance industry but the least promoted one is term insurance. It is the most economical and efficient way to insure yourself. Those who find that they need life cover should compare and contrast the term insurance products offered by various insurers and opt for the one that most satisfies their needs.
Term insurance covers the policyholder for a desired number of years against death, accident, disability, etc —- the same as other policies. In contrast, it does not have any maturity, paid-up, surrender or loan values. On occurrence of the contingency, the beneficiary gets the sum assured but on survival, the insured gets nothing.
Most investors have difficulty in accepting this. Since upon survival (or when the term ends) there is nothing the policy yields by way of maturity proceeds, those showing any interest in term insurance are often told that they are making a totally waste investment.
However, a plan that seeks to combine insurance and investment more often than not tends to be sub-optimal. It is always better to keep insurance and investments separate. All endowment, whole life and Ulips are examples of combination insurance plans. On the other hand, a term insurance plan has no cash payout at the end of the term. This means if the policy holder were to pass away during the term of the policy, his family will get the sum assured. However, were he to survive he will not get a single rupee. In other words, term cover is pure life insurance and has no cash or surrender value. If this is indeed the case, why favour term insurance as against a traditional endowment or whole life policy which, at least pays, at the end of the day, no matter what, either the sum assured or the maturity value?
The reason is (as mentioned earlier) because basically insurance is a cost. It is a contract (policy) in which you purchase financial protection or reimbursement against a loss or an unanticipated expense. The price paid to purchase such protection is also called premium in insurance parlance. Such premium is payable, year in year out, till you desire protection from the loss.
Now, take for instance car insurance. You pay the insurance premium, year in year out, to protect yourself against the financial damage an accident can cause. If you are a safe driver and manage not to damage your car during the year, the premium paid is lost - you don't get anything out of it. And you are perfectly happy to have done so, so long as you and your car are safe. Or take medical insurance. Again, premium is paid to defray any costs of medical emergencies or hospitalisation. However, if you remain fit and healthy the premium paid on buying the medical insurance is lost. But then again, you do not mind this, do you? Then why should life insurance be any different? But it is. It always has been.
The reason for this is mainly because life insurance premiums come bundled with the pure premium part combined with the part that gets invested on your behalf. The policy is sold more as an investment where the insurance just comes along.
However, you should know that insurance never comes along, it always has to be paid for. In the case of life insurance, the premium is known as mortality premium. Such mortality premium is applicable for all polices, year after year, without any exception, till such time that the life is insured. Even in the case of single premium plans or policies where the premium is payable only for part of the policy term, nonetheless, the mortality premium keeps getting deducted every year from the fund value. So, you buy insurance directly or indirectly each year.
In the case of any other policy, with or without bonus, whole life or endowment, actually the return on assurance component is also nil. However, it gets mixed up with the return on the investment component which could be (depending upon the exact policy) lower than other comparable investment products. Take care of this.
Tax benefits of lifeinsurance
As some cynic said, "There are only two certain things in life. One is death and the other is income tax." In India, death may be certain but income tax, with its vagaries of rules, is certainly not certain. So let's briefly examine the tax benefits associated with insurance.
For starters, any sum received under a life insurance policy, including the sum allocated by way of bonus is totally exempt from tax u/s 10(10D).
There are two exceptions:
1. Keyman insurance.
2. If the premium paid, in any of the years during the term of the policy, exceeds 20% of the actual sum assured, the maturity value received by the policy holder will be fully taxable. However, any sum received under such policy on the death of a person shall continue to be exempt.
Also, a deduction under Section 80C up to `1 lakh is available on premiums paid on policies in the name of self, spouse or children, major or minor, married daughters but not parents, dependent or not.
Where a taxpayer discontinues an insurance policy before premiums for two years have been paid, the deduction allowed during earlier years shall be withdrawn and shall be deemed to be the income of the year in which the policy is discontinued.
Conclusion
To reiterate, think of insurance as a cost and not an investment. Incur the cost only if you need to. Always buy pure insurance policies and not ones that are bundled with investment returns. In other words, buy term and invest the difference.
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