We are in the middle of this fiscal year’s tax planning period right now. February and March are two months when Indians, especially those with salary income, look around for investment options to save tax and also make some long-term savings in the process.
Life insurance plans are one of the most popular means to save tax. This is especially true of Indians in tier-II and tier-III cities, where insurance companies (especially Life Insurance Corporation or LIC) have a deep distribution network.
Every year, LIC also launches a new single premium insurance plan either in late February or early March to cash-in on the tax saving season.
Here are five thumb-rules to keep in mind if you are planning to buy a life insurance plan in the current tax-planning season.
1. Types of life insurance plans: Broadly speaking, life insurance plans can be put into two distinct boxes – one pure risk-coverage plans, and two, savings and investment plans with a modest amount of life cover on top.
Pure-risk cover plans protect the life and the earnings of the policy holder and are similar to general insurance products like motor or home insurance. The difference is that here, a life is being insured unlike a physical asset in case of non-life insurance products.
The second types are insurance plans which are largely sold as savings and investment instruments. These plans compete with other savings and investment products such as banks fixed deposits, post office FDs, corporate deposits or mutual funds.
Savings or investment linked insurance plans are much more popular in India than pure- risk coverage plans.
2. Common insurance plans sold in India: Here’s a list of common insurance plans sold in India.
· Term Plan – Risk or live cover for a specified period say till the age of 60.
· Unit Linked Insurance Plan (ULIP) – Insurance with opportunity to invest in equities
· Endowment Plan – Insurance plus savings
· Money Back – Periodic pay-back with an insurance cover
· Whole Life Insurance – Insurance cover for whole life
· Child’s Plan – A savings plan to fund life goals like child’s education and marriage
· Retirement Plan – Insurance cum savings plans for retirement planning
Note that any of these plans can be either single premium policy or they can be recurring premium policies. In a single premium, the policyholder pays one large lump sum premium at the time of purchase and enjoys benefit all through the policy tenure. As the name suggests in a recurring plan, premium can be paid monthly, quarterly or half-yearly.
3. Cost and benefit analysis of insurance plans. So, before you decide to buy an insurance plan it makes sense to do a financial cost benefit analysis of the policy you are buying.
But if you are buying any other life insurance plan, then break the premium into two components – the mortality charge and the investment component. Every life insurance plan provides a life cover and insurance companies provide this by deducting mortality charge from the premium amount.
For example, consider a 20-year Endowment Plan for a sum assured of Rs 10 lakh. Say this policy costs you an annual premium of Rs 60,000 inclusive of GST. To analyse it, find the cost of a plain vanilla 20-year term plan with a death benefit of Rs 10 lakh.
Let’s assume that such a term plan comes with an annual premium of Rs 5000. Now deduct the term plan premium from the premium on your chosen Endowment Plan. So in this case Rs 55,000 is the premium that will be invested by the insurance company to provide you financial return.
Now compare the return or sum maturity benefit offered by the insurance plan with a similar investment in banks FDs, post -office FDs or fixed-income mutual funds.
You can do a similar calculation for Money-Back plans, Children’s Plan, ULIPs or even a whole-life plan.
4. Work out your insurance needs before you buy multiple insurance plans. In life insurance, you are basically insuring your income or cash flows. So the sum total of the death benefit offered by all the insurance policies in your portfolio should be at around 5 times your annual income or should at least cover major financial liabilities such as home loan.
Alternatively, if you have a home loan with Rs 30 lakh then have a policy that at least covers this liability.
5. Lastly, stay away from the temptation of buying a new life insurance every year just to save tax. One of my colleagues had accumulated 15 LIC policies over the years with an aim to save tax and make some savings. However, adjusted for mortality charge, insurance plans are an inefficient and costly way to save. It’s best to buy a pure vanilla term plan for the sum assured that best suits you. Shop for savings and investment products separately.
(Advice: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).