Term insurance tax benefit has become the number 1 sales driver in India. Sadly, many don’t know or just ignore the basics of buying term insurance and buy term insurance just to save tax or worse as a saving option. That is the reason why endowment plans became so popular in India. In this article, we will talk about all the important aspects that you should understand about term insurance.
What is term insurance?
Term insurance is a type of insurance plan wherein you pay premiums every fixed period (generally annually) and the nominees get a lump sum amount in case of the demise of the insured.
Why is it important?
The untimely death of an earning member can leave the financial situation of the family in chaos. This is especially true if that person is the only earning member of the family and savings are insufficient.
Term insurance if bought correctly, provides a large sum assured which can help provide the same standard of living for the surviving members of the family.
Hence, its importance can’t be stated enough to secure the future of the family.
Term insurance tax benefit
The government gives tax benefits for the purchase of term insurance because it wants to promote the idea of securing one’s family’s future. However, as stated above while this is clearly not the intended primary benefit, this has become the number 1 reason why most people buy term insurance.
As to the tax benefit some people have the confusion whether term insurance comes under 80C or 80D. To clarify, term insurance tax benefit can be availed under section 80C and one can save upto 1.5L from taxable income for the premiums paid for self, spouse and children.
Section 80D covers health insurance, which is also an important aspect of financial planning. Some riders which we will talk about later in the article are covered under Section 80D.
Recommended Read: How to buy the right health insurance for parents?
Term insurance vs Life insurance
While used interchangeably, term and life insurance are not the same. Term insurance is a type of Life insurance wherein while the premiums are low, there is no maturity benefit. There are other types of Life insurance plans also where there are maturity benefits. These are referred to as ULIPs, Endowment plans, etc.
Indians are usually averse to paying for something wherein they see that they might not get anything in return and the money in premiums will get wasted. Hence, these life insurance products with maturity benefit were born to:
- avoid this perception of waste of money,
- satisfy the need for saving on income tax, and
- namesake insurance purchase – remove the guilt of not having insurance
Since there is a surety of payment at maturity, these are not primarily insurance products but investment products and only a small premium goes toward insurance. Consequently, the insurance amount is also low, and the primary purpose of safeguarding the family’s future remains largely unfulfilled.
While these products did push many people toward purchasing life insurance, these are also the biggest culprits in the underinsurance. Since these products were born in times of lax regulations, the agent commissions were huge (like term insurance commissions and not like any other investment option) which led to both bad returns and low coverage of risk.
Hence, it is always advised to buy term insurance for safeguarding the family’s future and to do investment for gains separately.
Who should buy and when?
Any person earning currently (or having earning potential) and having one or more dependants should buy term insurance because their untimely death will cause that earning potential to disappear. In absence of insurance, the dependants will have to modify the standards of living to adjust with the lower or no income which is not desirable.
It is often a fallacy that only married people should buy insurance. All people even if unmarried but who have dependents (maybe parents or siblings), should get insurance. They should increase the insurance amount if the responsibility increases (got married or a child is born?) and decrease once the responsibilities come down.
Buy for the entire family?
People who don’t take life insurance don’t take even for the earning member but people who do take it, take it also for the non-earning members even small children. While agents who get commissions for selling insurance might propagate this, in my opinion this is an incorrect approach.
Getting insurance is not an investment done for the sake of return. It is required when dependants are counting on the person’s future income to make ends meet or fulfil liabilities (like home loan, children’s marriage, higher studies etc).
Hence, if there is a huge loan being taken for a child’s higher studies assuming that he will earn and repay it – take insurance, however, if the child is in class 5 – no point in taking insurance. Similarly, if there are other non earning members in the family (75-year-old grandfather) – no point in buying insurance. The premium is better spent in increasing the sum assured against the earning member’s policy.
How much sum assured to take?
Generally, people advise 10 times the yearly income or 120 times the monthly income for insurance. However, the income might be very high or low at any period of time but if it can be afforded, taking insurance as per the pending liabilities and spending habits is a better option in my opinion.
For example: if a person is earning 20L per annum then, the income approach will suggest buying 2Cr insurance. However, let’s assume that one person is a bachelor with earning parents and the other person has a family of 4 to support. In both cases, the insurance requirement is different – more in the latter, and if affordability is not a big issue, larger insurance must be taken.
After some time if the 1st person gets married and the spouse is not earning then insurance should be increased.
It might be a good idea to keep sum assured at least 20 times of the annual spend requirement. The idea is that the expense requirement (1/20 = 5%) can be fulfilled using the investment income from the sum assured and the remaining income (over 5%) will increase the base amount to combat inflation and helping out in other emergency situations.
This is the minimum recommended amount, and keeping some buffer would be even better.
Also, if affordability is a concern, the minimum sum may be calculated after removing the constraints. For example, if the earning member is no more there is no constraint to live in the metro and give high rents when there is already a house in hometown.
One vs multiple plans
We have been talking about increasing and decreasing insurance according to life stages.
For example: buying a 1Cr house on loan (80L) and you are the only earning member of the family? The 1 Cr insurance that you already have, will not suffice now. Better get additional insurance of 80L so that house loan is taken care of in case of a mishap.
Now, to increase this cover – it is better to take multiple policies and not keep adding in the same policy. It would be easier to surrender some of the policies in case the liabilities go away. Paid off the home loan? Give away the policy.
Riders – must add or useless?
There are a host of riders now available with life insurance policies. As explained above, insurance is taken to protect against the loss of earning capacity. This can happen because of death, but also disability because of accident or disease of the policyholder.
In case of disability, the condition might be more severe because there might be more mouths to feed, and also medical expenses may also press down on the financial situation. Hence my recommendation is that one should carefully take these riders also to protect oneself and family in these situations.
Recommended Read: How to buy the right health insurance for parents?
While longer tenure is better at ensuring there is a payout, the premiums are higher for higher tenure. Again, thinking about insurance as a protection against loss of earning ability and not investment – tenure beyond earning period might not be required.
Early retirement and no more liabilities or responsibilities to fulfill warrants that money is not spent on insurance premiums – certainly, if health is in good condition and near death seems unlikely.
Which Insurer & Online or Offline?
Insurers should be chosen carefully and the claim settlement ratio should not be the only metric to base this decision upon. While IRDA does have multiple regulations in place so that fraud does not happen, insurance is bought for peace of mind and that should be paramount.
Hence, you should buy a policy from the company which you are confident about. Do not buy a policy from a company if you have doubts about the company, even if the premiums are low.
There are multiple aggregators online where you can do easy comparisons about the features and premiums. While generally, you might find better deals online, there is no harm in checking prices offline once the policy decision is finalized.
Nomination & communication
It is imperative to fill proper nomination at the time of buying the policy. Please check the details at the time of buying and ensure that the details are correct even if you have not filled yourselves. Proper disclosure and nominee details help in case of a claim.
Also, ensure that nominees and some close ones know about the policy so that in case a situation for a claim does arise, people do know that such a policy is there.
Insurers have over 15,000 crores out of which LIC has 10,500 crores of unclaimed amount
Term Insurance tax benefit should not be the only concern while purchasing life insurance, it is not even the most important. Breadwinners should buy life insurance so that their dependants don’t have to face financial distress at the time of emotional turmoil.
So, buy adequate term insurance from reputed providers and ensure that you are at greater peace with your mortality knowing that your loved ones would be taken care of.
Ravi is an IIM ranker with over 9 years of work experience and has helped optimize the growth and financial performance of companies like BPCL, Sun, Ola, Swiggy, Curefit, and Rupeek. In this blog, he explains how to improve personal finances, do growth hacking through digital marketing or other initiatives, and provides a sneak peek into the financial models of companies – especially startups.