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While it is a fact that we need insurance to protect our family in case of life risk, we also need to be judicious while buying insurance products. Unfortunately, most of us take insurance policies merely to save tax and in the process get saddled with products that don’t meet our needs or are very expensive. Therefore, one should always analyse the objective of buying the insurance plan and evaluate the product’s suitability before making the investment.
Following are insurance products that one should have. But even for some of them, one should consider alternatives if there are any and look at all pros and cons before buying them.
Term plan
Term plans are the purest and cheapest form of insurance, which provides optimum life cover without any maturity benefit.
There are two types of plans available:
Without Return of Premium You pay your premiums for the stipulated term, until which time your life risk is hedged. In case of eventuality of the life assured, the sum assured will be paid out to the nominee. If the policyholder lives beyond the currency of the policy, he does not get any money.
With Return of Premium Here again, the insured pays the stipulated premiums (normally higher than the plain vanilla plan) and at the end of the term, the premiums are returned either as-is or with a minuscule return.
Health insurance
One needs to assess one’s health risk and hedge the same. Healthcare costs have been rising at rates significantly higher than the inflation rate. Choosing the right medical cover could be a daunting task. One should understand that there are few expenses which will be covered by default by most of the medical insurers. What you should be looking for is if there is any extra edge in availing a different product. While planning for the family, one can avail a family floater, which will be cost effective.
Retirement/pension plans
In the absence of any social security in India, planning for retirement is something each one of us should do. Pension plans are offered by life insurance companies with a view to help investors build an adequate corpus for retirement. On maturity this corpus is invested for generating a regular income stream, which is referred to as pension or annuity. In pension plans, one has the option of withdrawing one third of the maturity amount in lumpsum, while the remaining two thirds has to be compulsorily invested in an annuity (paid out in regular installments). The direct tax code proposes to make the maturity value from pension plans tax free; at this point tax is the major drawback.
Before deciding to buy a pension plan from an insurance company, you must also consider New Pension Scheme as the biggest advantage is the low cost. You can even consider a combination of the two for your retirement planning.
Child plans
Child insurance plans are meant to benefit children; primarily to save money for their education and marriage. On an investment objective basis, one could categorise child plans into Traditional (invests in term deposits, GOI / Corporate bonds and so on) and Unit Linked Insurance Plans (which invest in debt and equity funds).
Some of the child plans also provide the Waiver of Premium (WoP) rider benefit wherein, on the eventuality of the proposer the future premiums are waived off and the policy will continue to offer payouts as pre-determined. This is in addition to the sum assured being paid out on life risk when the life cover is on the parent.
Some insurance companies have child plans where the life assured is the child and not the parent. Such plans should clearly be avoided as they do not serve the very purpose of the policy. If one has a lumpsum amount, then tax free bonds are an option while planning for your child’s education. Public Provident Fund is also an option for planning of your child’s education requirement. You need to also take a term plan to cover a very important need. However, term plans give you the sum assured immediately on life risk and the nominee would then need to invest this into some avenue to take care of this need when it comes up.
Endowment plans
Endowment Plans are basically plans that combine life cover and provide a return (maturity value). They are mainly traditional plans and have a low risk and this can be used for your needs. This is a conservative option that will provide debt like returns.
If you want to plan for an alternative to endowment plans, you could use a combination of term cover plus invest into debt options like long term tax free bonds and PPF. Debt MFs are an option; however, considering that Endowment Plans are long term, short term debt funds maybe inappropriate and long term income funds are subject to interest rate risk. Most other debt options are tax inefficient and, hence, not appropriate.
Unit Linked Insurance Plans (Ulips) Ulips are market linked plans that combine life cover and market-linked instruments. Compared to traditional plans, they are more flexible in allowing for early withdrawals. Most plans allow the investor to chose the funds that they would like to invest into and, hence, one has an option of both debt and equity investments through the ULIP.
But there are some things to keep in mind before investing in Ulips. One school of thought is that one should not combine insurance and investments. The right way would be to for a separate term cover and invest into mutual funds or other investment avenues.
Earlier ULIPs had a very high cost structure. IRDA has addressed this issue today and on a cost basis, ULIPs can be even cheaper than mutual funds due to the lower fund management charges than MFs. If cost is a point of consideration, one should evaluate the options on an excel sheet in an un-emotional way.
The other point to keep in mind is that you need to look at a much longer time frame when you mix life cover and investments. Traditional plans offer poor liquidity over the full tenure, while ULIPs are restrictive till about five years. Some ULIPs offer highest NAV plans. They are complex and investors need to understand that the highest NAV plans could result in lower returns.
The author is a certified financial planner