A simple guide to Life Insurance

Investing in life insurance is crucial to safeguard your future and that of your loved ones. Here’s everything you need to know about buying the right policy.

A simple guide to Life Insurance

While it might be universally agreed that life insurance is critical but few know about its various benefits. Even fewer would have purchased one themselves. This is because most people do not understand the true benefits of this simple, yet effective tool.

This simple guide will explain what life insurance is, why you need it, the different types available and how you can make the right decision choosing the best insurance policy for yourself.

What is life insurance?

Life insurance brings financial protection in the face of an unfortunate event. It provides a cover for the loss of income that would result if the insured passed away. The proceeds go to a beneficiary. It helps family members of the insured to meet financial needs post his/her death such as paying off home loans, financing the education of children, ensuring a marriage fund, and other such important life events that might require financial assistance.

Why do you need life insurance?

There are multiple benefits of life insurance:

Firstly, if your family is financially dependent on you, the pay-out from the life insurance policy ensures their security and independence.

Secondly, it can be a very effective tax-saving instrument as it comes under the EEE tax bracket, which means it is exempted from tax at the time of deposit, interest accumulation and withdrawal.

Thirdly, if the policy matures in your lifetime, you can use the lump sum amount to pay off loans, study or travel.

Now, that you have understood the importance of buying a life insurance policy, the next step is to learn the various types of policies and then making the right decision to buy the one that fits your exact needs.

Types of life insurance

1. Term plan

A term plan is the cheapest form of life insurance where a certain amount (called death benefit) is paid to the policyholder’s family if they expire within the term of the insurance policy. The insured does not get their investment back in their lifetime. The proceeds only go to the beneficiary in the event of the policyholder’s death.

2. Whole life plan

A Whole life plan is a type of insurance that has an insurance and investment component. The insurance component ensures that the policyholder’s family is financially supported in case of their death. The investment component accumulates in value over the years so that the policyholder can withdraw it or borrow loans against it to use for any need of his. This can only be done after a certain period of paying premiums, which will be mentioned in the policy.

3. Endowment plan

An endowment policy is one that promises the payment of a lump sum amount after a particular term on the policy’s maturity or on the policyholder’s death. Some policies assure payment even in the case of critical illnesses.

4. ULIPs

Unit-linked insurance plans (ULIPs) are insurance plans where a part of the premium is invested in equities, government securities, debt funds, etc., thus linking their performance to the financial market. These plans create a possibility of high returns on investment in the long-term, with the additional benefit of life cover.

5. Money back

This plan offers survival benefits to the policyholder. This essentially means that the insurance company pays a portion of the assured sum at regular periods to the insured. Money back insurance plan is a great way to ensure regular income to fund short-term financial requirements.

6. Retirement plan

Investing in a retirement plan is the smartest move one can make. Such a plan ensures the policyholder is not dependent on anyone post-retirement. The premiums policyholders pay go towards building a corpus for their retirement. 

How to pick an insurance plan that suits you

Let us consider an example where we have Rajat who is 39 years of age. His financial particulars are given below:

From the chart above, we understand that Rajat’s expenses use up a major part of his salary, which makes him partly dependent on his wife’s salary to manage the expenses incurred on his children. In the current scenario, Rajat is unlikely to commit to any periodic regular payments apart from the ones he already has to pay.

Now if Rajat passes away due to some unforeseen circumstances, his family will face a heavy financial burden. His wife will receive a sum of INR 10 lakh from his life insurance, but she will have to pay an outstanding balance amount of INR 20 lakh against their home loan. Her salary will not meet the expense amount; hence she will either have to choose between selling the house or cashing in all the family savings to retain the house.

Unfortunately, Rajat did not plan his insurance properly and his death will place his family under financial stress.

What Rajat should have done instead?

Rajat should have realigned his portfolio such that allocation of funds was more leveraged towards products with higher returns as long as risk appetite was managed. This essentially means lesser investment in FD and PPF, and more in mutual funds. The returns should have been used for better insurance benefits. 

He should have invested in a term insurance plan that covers purely death risk. Term insurance provides a big insurance cover at a low cost. For less than approximately INR 20,000 per annum, he could have got a term cover of INR 1 crore.

He should have planned such that the insurance coverage could have not just taken care of all liabilities (home loan in this case), but also provided for his family for at least 5-10 years more. He should have built a corpus after accounting for inflation. This means a corpus of additional INR 40 lakh considering his monthly expenditure. Accounting for the outstanding home loan, Rajat’s insurance cover should have been minimum of INR 60 lakh.

He should have also invested in a separate health family floater insurance policy. The INR 3 lakh cover provided by the company would be inadequate to take care of average range ailment or accident for even one person, let alone the entire family. A family health floater plan would have ensured his family being covered even after his death.

There are many great insurance products available in India today. Do your homework and understand the benefits of each, consider the financial needs of your family, do the math and invest in the right policy so your family can live the life you want them to.


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