The size of insurance coverage, cash value, repayment process, and investment-related policy returns should be considered when purchasing a life insurance policy.
Most taxpayers would have one or more insurance products, but a large majority would have purchased insurance for the wrong reason, i.e. to save tax. In fact, the last quarter of every year, from January to March, is the busiest season for all insurance companies because they get maximum business during this time. This is when taxpayers make the mistake of buying insurance just to save tax. Eventually, they end up with expensive policies that they actually don’t need. So, every policy buyer should check the following aspects before buying insurance products.
The term “life insurance” is a general term used for different types of policies. So, before buying, you should know that the share of life cover in all insurance policies is not equal. If you’re buying life insurance to protect yourself, getting significant coverage at the given premium should be the top priority, not the tax-saving item. The rule of thumb is to opt for life coverage equal to 10 times your annual income or total assets and 300 times your monthly expenses. If an unfortunate incident occurs, the life insurance policy will act as a financial life jacket for the family.
It is essential to verify the yield in the case of an insurance-plus-investment policy. There are many unit-linked insurance plans that combine insurance and investment. In these policies, the objective is to provide market-related returns and insurance coverage is not a priority. There are several such products that are extremely inexpensive in terms of premium and give you a wide variety of investment portfolios to choose from. Policy buyers should note that returns are linked to the underlying asset. Moreover, in the majority of endowment and reimbursement policies, the internal rate of return usually does not exceed 5-6% per year, even after adding bonuses, guaranteed additions, etc. Policy buyers should note that insurance policies that guarantee a fixed sum at maturity generally charge a higher premium to provide such returns.
Lump sum or installment payment
Before buying the insurance policy, find out exactly when the policyholder or agent will receive the money. In the event of risk (death of the insured), the agent/legal heir will receive the sum insured. If there is no risk and the policyholder survives, then the policyholder gets the benefits at maturity.
It is also important to know how the sum insured is disbursed. Check with the insurer if, at the time of maturity, you will receive the entire sum insured as a lump sum payment or if the money will come in installments to meet major expenses such as the wedding of a child, higher education, etc.
The surrender value is the amount the policyholder will get if he voluntarily surrenders the policy before it matures. Redemption may be due to reasons such as job loss, financial stress, distressing problems, etc. Although some types of insurance policies offer some cash value, not all do. Cash value differs from policy to policy and from life insurer to life insurer. Be sure to ask about cash value and base your decision to buy the policy on that.
To conclude, any momentary financial mistake can affect not only your financial well-being, but also the rest of your life. So, don’t just look at the tax savings when purchasing an insurance policy; instead, consider all of the above points to arrive at your decision.
LOOK BEYOND TAX
— Opt for life coverage that represents at least 10 times your annual income or total assets and 300 times your monthly expenses.
— At Ulips, the objective is to offer market-related returns and insurance coverage is not a priority
— Although some insurance policies offer a cash value, not all offer the possibility of
— Check when and in what proportion the policyholder or the agent will receive the benefits on maturity or the sum insured respectively
The author is Professor of Finance and Accounting, IIM Tiruchirappalli.