If you are an earning member of your family (current or future), apart from the emotional loss, your death will also result in a significant financial loss to your family going forward.
Your family bears this risk of financial loss (associated with your death) every day.
This is where life insurance comes in.
Life insurance is a product which aims to reduce this risk of financial loss to your family by assuring to pay a lumpsum to your dependents in the event of your death.
Hence it is a pure risk reduction tool.
If you don't have any income or anyone dependent on your income then there is no financial risk to be insured and you don't need life insurance.
However, there are many insurance policies which are insurance-cum-investment products.
At Goalwise we recommend that insurance should never be mixed with investment.
When you mix, typically neither your insurance need nor your investment need gets fulfilled!
However, it is always a good idea to know about all the types of insurance policies available, so that you are not caught off guard.
1. Term insurance plan
Term life insurance is a pure insurance product where only the life of the insured is covered and there are no investment related contributions - just like a car insurance.
You choose a lumpsum amount (i.e. sum insured or life cover) to be paid in the event of your death and pay an annual premium according to that amount.
So, if you have a term insurance plan and you happen to die within the policy term, then your nominee would get the entire sum insured, i.e. the life cover amount, and the policy would terminate.
However, if you outlive the policy tenure, then nothing would be payable to you or your family members and the policy would terminate.
A term policy usually has no savings component and so it has only death benefit and no maturity benefits.
Who needs a term plan?
Simply put, everyone who has financial dependents needs a term plan!
A term plan is inexpensive and does not require any investment related contributions there by making it suitable for anyone who needs life insurance.
For eg it is well suited for a person who is one of the primary breadwinners of the family. He can buy the plan and if he dies unexpectedly, the death benefit will provide financial relief to the family.
Similarly, term plans are also good for people who have a high net worth and need a large cover for themselves.
Features of a Term Plan
- Pure insurance plan, no savings component.
- Lumpsum payout in the event of death of the policy holder.
Pros of buying a Term Plan:
- Cheapest life insurance plan since it is pure insurance.
- Death benefit is tax free
- Premium paid is tax free U/S 80C till INR 1.5 lakhs p.a.
- Fixed premium – No matter the length of your plan, your premium will be fixed throughout, and so you don’t have to appear for medical tests, etc. during the policy tenure as you age.
- Riders – A term plan can be customized by adding additional riders such as waiver of premium, accidental death, etc.
Cons of buying a Term Plan:
- Hardly any except the fact that there is no maturity benefit, so people may feel that their money paid as premium is 'wasted' which is not the case since you are not paying for any investment contributions anyway.
- Similarly, term plans do not have any surrender value. So, if you choose to stop your policy mid-way, there is no money that would be returned to you.
So, should I buy term insurance?
Of course, if you have dependents you should definitely buy term insurance.
In fact it it is the only type of life insurance you should buy.
Ok, now we will talk about all the other types of Life Insurance products that exists in the market, but all of them are some combination of insurance + investments and hence not recommended.
It is much better to plan your investments separately as per your financial goals instead of giving up control to life insurance companies.
So with that caveat, here goes-
2. Whole life insurance plan
Whole life insurance plans are like term plans but with an indefinite term.
A whole life plan is also a pure protection plan. However, there is no fixed tenure. Whole life plans run till the lifetime of the insured (or till the insured reaches 99 or 100 years of age).
They pay the sum assured if the insured dies any time before attaining 99 or 100 years of age.
Because of this indefinite period of cover, the premiums are somewhat more than in case of term plan which has a fixed term (eg 30 years).
Features of a Whole Life Plan:
- A whole life plan is a plan without term restrictions, i.e. it provides coverage for the entire lifetime.
Pros of buying a Whole Life Plan:
- Coverage for the insured for his/her whole life
Cons of buying a Whole Life Plan:
- More expensive than Term Plans
- Cover for entire life is typically not needed
Our recommendation: Life cover is not typically needed through out your life. You only need it till you have dependents, so a term plan till 60 years of age will do and will be cheaper than taking insurance for your entire life.
3. Endowment plan
Endowment plan is a savings-cum-insurance plan which promises a death benefit in case of death during the term and also a maturity benefit if the insured survives the term of the plan.
The returns are usually very low (even lower than FD in many cases), barely enough to meet the inflation and the insurance coverage is also low, as this is a combination of insurance + investment plan so most of your premium goes towards investment and investment related expenses rather than insurance.
These type of plans have a lot of hidden fees especially on the investment side and hence are usually the most (mis)sold insurance products today.
Features of an Endowment Plan:
- A savings-cum-insurance plan with some guaranteed returns (around 4%)
- There is death as well as maturity benefit in endowment plans.
Pros of buying an Endowment Plan:
- Tax Benefits- under section 80C as well as 10(10)D
Cons of buying of buying an Endowment Plan:
- The insurance coverage is low, as compared to the premium paid and the return on investment is also low.
- Contrary to the marketing pitch, most policies have returns less than or equal to FDs and the bonus rates are not guaranteed.
- The policy tenure is usually 10-15 years minimum. The savings part can not usually be touched till the policy matures.
Our recommendation: Endowment plans are bad and should be highly avoided. You lock your savings for 15-20 years that too for returns less than that of an FD. And if you end up discontinuing your policy mid-way then there are heavy penalties even on the investment side. Avoid!
4. Money back plan
A money back plan is like an endowment plan but with a major difference as explained below.
How does a Money Back Plan work?
A money back plan is an anticipated endowment plan which guarantees periodic returns along with a maturity benefit or a death benefit. It simply means that this is a plan wherein you get money at some interim periods as well ('money back'), which is defined at the beginning of the tenure.
For example, you get 5% of the sum assured back every 5 years, for the 5th, 10th, 15th and 20th policy year. This is called as survival benefit.
The remaining 80% + Bonus is paid at the end of the policy tenure as Maturity Benefit. However, if the life insured dies within the policy tenure, the entire sum assured + accrued bonus would be paid to the nominee as death benefit irrespective of the amount paid out at survival benefit till then.
Features of a Money Back Plan:
- Money Back Plan is a traditional insurance plan with guaranteed benefits, but with interim returns at defined intervals.
- There is death as well as maturity benefit in endowment plans along with survival benefit.
Pros of buying a Money Back Plan
- It gives regular pay-outs during the term of the plan at pre-defined intervals, so there is some liquidity
- Tax benefits under section 80C
- Guaranteed (but lower than FD) returns
Cons of buying a Money Back Plan
- Money Back plans have one of the worst returns on investment
Our recommendation: Money back plans are similar to endowment plans and both should be highly avoided as they are both investment-cum-insurance products with high commissions and low returns on the investment part. Better to use a term plan for insurance and invest separately according to your goals and needs.
5. Unit Linked Insurance Plan (ULIP)
Unit Linked Insurance Plans or ULIPs are also investment-cum-insurance products. The difference is that in a ULIP the investment part of the premium is invested in equity or debt funds (similar to mutual funds) and hence the investment returns are market-linked.
As the policy holder you get some choice in deciding how the money is invested between equity, balanced or debt funds.
So the returns are no longer guaranteed and depend on your investment choices and market performance i.e. the investment risk is borne by you.
Life insurance cover is also provided by the plan as it pays a death benefit if the insured dies during the policy tenure.
Features of Unit Linked Insurance Plans:
- Insurance coverage + market-linked investment options.
- There is death as well as maturity benefit in Unit Linked Insurance Plans.
Pros of buying a ULIP
- To get market-linked returns
- ULIPs have multiple tax advantages:
- The premium invested is tax-free U/S 80C, as is the case of other insurance policies
- The maturity benefit is also tax-free U/S 10(10)D, as is the case of other insurance policies
- The funds can be switched from equity to debt and vice versa without any tax implication. So, there is no LTCG or STCG taxation involved.
Cons of buying a ULIP
- ULIPs are heavily front loaded with complicated charges which reduces the return on investment
- The insurance coverage is only 10 times the premium which is not sufficient at all
- Lock-in of 5 years
Our recommendation: A ULIP is basically insurance + mutual-fund investments but with a lot of hidden costs which ultimately lower the returns as compared to Mutual Funds. Also, the universe of funds to choose from is limited hence you don't get access to the best Mutual Funds possible.
6. Child insurance plan
Child plans are specifically designed insurance plans to create funds for the child’s higher education, marriage, etc. Thus, a child insurance plan is a savings-cum-insurance plan which creates a guaranteed corpus for the child’s future whether the parent is alive or not.
Features of a Child Plan:
- A plan especially designed for a parent with triple benefit - death coverage, maturity benefit at the end of the tenure + premium waiver benefit
- Child plan can be both traditional as well as unit linked.
Pros of buying a child plan
- The best part about a child plan is the premium waiver rider. The rider continues the premium payments even if the insured parent dies.
Cons of buying a child plan
- Like other investment-cum-insurance products, teturn on investment is very low (even lower than FD)
- You will get more money by just investing in FDs and Mutual Funds.
Our recommendation: Stay away from any such child plans. Most of these traditional insurance-cum-investment plans dangle the carrot of 'guaranteed returns' but hide the fact the returns guaranteed are usually less than even an FD in their fine print which none of us ever read. In most cases you are better off just leaving your money in an FD or a debt fund.
Annuity plans are typically a post-retirement product which pay a regular income through out the insured’s lifetime.
Annuity plans are the mirror-image of other life insurance plans in the sense that in a typical annuity plan, you pay a big lumpsum upfront to purchase the annuity plan and the insurance company then makes periodic payments to you till you live (thus creating a 'life time pension').
The big lumpsum that is paid upfront to the insurance company typically comes from your life-long savings towards your retirement.
The risk that is being covered by annuity plans is the risk of living too long.
For example, let's say you have 1 Crore at your retirement with which you can fund your post-retirement expenses for 15 years. But what if you end up living beyond that?
Annuity plans provide you a life-long income stream and the annual payments can be in the range of 6-10% of the initial lumpsum.
Sounds good, so what's the catch?
The catch is that you are giving up the lumpsum corpus to the insurance company. So in case you end up dying sooner, say just after a year of taking the annuity, even then the lumpsum money that you purchased the annuity with, is gone.
An alternative to an annuity plan would be to put the lumpsum in FD or Debt Funds (or some combination of Debt and Equity Funds if there is some risk appetite) and get periodic interest from that lumpsum. The benefit here is that the lumpsum still belongs to you and can be passed on to your nominees when you die.
How does an Annuity Plan work?
A general annuity plan works in two phases, the accumulation phase and the annuity phase. During the accumulation phase, the policyholder has to pay the premiums. He has the option of paying it in one go, or the premium is divided and paid throughout the years. Once he finishes paying the premiums, his annuity phase starts and he receives the monthly payments.
There are basically two types of annuity- Immediate Annuity and Deferred Annuity.
- In Immediate Annuity, the payment needs to be done in a lumpsum and the annuity starts immediately according to the annuity option chosen.
- In Deferred Annuity, the payment needs to be accumulated over a period of time and the annuity starts from the chosen age according to the annuity option chosen.
Variations of annuities:
There can be several variations over a simple annuity. Examples:
- Fixed Life Annuity that is payable at a fixed rate. (the simple case)
- Increasing Life Annuity at a simple rate of interest at 3%. p.a.
- Life Annuity along with Return of Purchase Amount.
- Life Annuity with 50% or 100% of annuity payable to the spouse for his/her entire life after the death of the annuitant.
- Life Annuity with 100% of annuity payable to the spouse for his/her entire life after the death of the annuitant along with Return of Purchase Amount.
An annuity with Return of Purchase Amount is similar to having your money in FDs and getting 6-7% interest income per year. Hence the pay-outs on such annuities are in the range of 6-7% only.
Higher %-age pay-outs are only found in annuities without any Return of Purchase Amount option.
Does an annuity plan provide life cover?
No, an annuity plan doesn’t provide life cover, though these products are sold by life insurance companies in India.
If the Return of Purchase Amount option is chosen and the annuitant dies, then the nominee will get the Purchase Amount back as a lumpsum but there is no extra life cover provided.
Pros of buying an Annuity Plan
- Covers the risk of living too long with lifetime guaranteed income
- Annuity can be taken for joint lives and might cover both married couples
- Multiple variations of annuity options available
Cons of buying an Annuity Plan
- You give up control of your retirement corpus used to purchase the annuity. It cannot be withdrawn as a lumpsum if need be.
- If you choose the Return of Purchase Amount option, the returns offered are similar to FD.
- Annuity is taxable in the hands of the annuitant and is taxed as per slab.
Our recommendation: Annuities cover the risk of outliving your savings which is a genuine risk, so as a concept they do have some utility. But their current pay-outs are not attractive enough when compared to structuring the same through FDs or Mutual Funds where there is the additional benefit of still owning the lumpsum. So while you may consider choosing an annuity after you retire, please consult your financial advisor to ensure that the pay-outs you are getting are attractive.
Once you know the various types of life insurance plans available in the market, you just need to stay away from all of them apart from term insurance and possibly annuities.
If you need insurance coverage, then opt for a term plan with the maximum coverage that you can think of, but never mix investment with insurance and settle for any of the other plans.
Investment products should be taken separately and as per your financial goals and not mixed with insurance.