Life insurance policies are one of the most common ways to secure your family's financial future. A right life insurance policy will not only take care of your family’s financial needs but could also help you retire rich or achieve long-term financial goals such as funding your children's higher education, marriage, pension or house construction. Life insurance can also be used to save on income tax.
The premium paid on life insurance policies are tax-deductible under Section 80C while the maturity proceeds are tax-exempt under section 10 (10d) of the Income Tax Act, provided the premium amount does not exceed 10 percent of the sum assured for any year during the premium paying term for the policies issued after April 1, 2012.
But as the number of insurance companies has multiplied so has the diversity and complexity of life insurance plans in the market. This can make it tough for you to choose the right life insurance plan for your family. Follow these five steps and you will never buy the wrong life insurance plan:
1. Why do you want to buy a life insurance policy? This is the most important question that you should ask yourself while buying a life insurance policy.
For example, pure term plans only insure your earnings capacity and don't pay back a penny if you survive its tenure. Then there are endowment plans, whole life plans and money-back insurance plans that can be used to make long-term savings and investments besides providing a life cover to your family.
Additionally, you can buy a plan that meets your long-term financial goals such as funding your children’s higher education or marriage. Then some plans offer pension benefits and can be used for retirement planning.
Finally, there are unit-linked insurance plans (ULIPs) that invest the premium proceeds in the stock market and offer much higher returns over the longer term than the traditional insurance plans.
2. How much insurance premium can you spare every month? Various life insurance plans are not only designed to meet specific financial goals but also tailored to your savings or investment capacity. If you are low on budget but still want to secure your family’s financial future, then you should only buy a pure term insurance plan. These are pure-play insurance products that offer the highest sum assured for every rupee of premium paid. Under the plan, your nominee will get a large lump-sum amount in the unfortunate event of your demise.
The Term plans usually last till you reach the age of retirement or 60 years of age and there are no benefits if the policyholder survives the policy tenure.
If you find pure term plans a waste of money, then buy a return of premium term policies. As the name suggests under premium term plans, you will get back all the premium that you have paid during the policy terms if she survives the policy term.
In contrast, if you can afford to pay a higher premium you can opt for endowment or whole life plans that offer the combination of long-term savings, retirement planning and life cover in one policy. These plans can become part of your financial planning and can be used as a substitute for investment in fixed income instruments such as bank fixed deposits or debt mutual funds.
3. What are your long-term financial goals? At the end of the day, life insurance policies are yet another way to save and secure your family's financial future. So they must fit into your long-term financial goals. For example, if you are already saving and investing for your future through mutual funds, stocks, bank FDs and provident funds but want to ensure your earnings or salary then just settle for term plans with a sum assured that is at least 10 times that of your current take-home earnings.
Some endowment plans are LIC’s Bima Jyoti, Jeevan Anand or Jeevan Lakshya. You can choose a specific endowment with a specific tenure to save for a particular financial goal in your life. Most endowment plans also have a single premium payment option that can be used to make financial gifts to your kids or grandkids to provide them with a recurring or lump sum income once they reach adulthood.
4. What is your investment horizon? Life insurance products other than term plans are long-term savings and investment products but policy terms are not open-ended. All savings-cum-insurance plans involve a period of lock-in wherein the maturity benefits are only paid after you have paid the premium for a certain number of years. These can be just two years or 30 years depending on the plans and the policy tenure selected by you. And most often the best returns are offered by plans where lock-in is the longest.
The longest-running plans are whole life plans like LIC Jeevan Umang which pays out benefits till the policyholder turns 100 years of age. These whole life plans can also be used to leave a big lump-sum amount for your next generation. Those with a shorter investment horizon can opt for endowment or money back plans such as LIC Dhan Rekha.
5. What is the claim settlement ratio of the insurance company? If you have already decided about the kind of insurance policy to buy for your family then, the claim settle ratio should be the most important parameter when selecting the insurance company. The insurer’s claim settlement ratio is the ratio between approved or settled claims to the aggregate claims filed by the policyholders in a given year.
Industry regulator Insurance Regulatory and Development Authority (IRDA) regularly provides data on claim settlement ratios for various insurance companies. Use that to choose the most reliable insurance company for your family. Everything else being equal, you should buy a product from an insurance company with a higher claim settlement ratio.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).