Fenil's Library

Life insurance is a necessity, not an investment. But it is required only if the demise of the breadwinner will put immense financial pressure on family members

Sandeep Shanbhag

I am often asked whether life insurance products are good investments. The following is my detailed answer.

Life insurance is a necessity and not an investment. There is no substitute for life cover, none whatsoever. It is the only means of providing security to your near and dear ones against your untimely death or to yourself against your old age.

The yield on investment per se, to that extent is of lesser importance. The ‘cover’ or ‘protection’ overrides all other considerations. However, note that it is a necessity, if and only if, the demise of the breadwinner of the family will put immense financial pressure on the family members left behind.

However, if that is not the case, you must reconsider your options. Every product has an associated cost and so does insurance. Do not buy a product you do not need. Excessive insurance injures financial health. It is very important to carry out a cost-benefit exercise before buying a policy.

Never ever buy an insurance product with the sole purpose of saving tax. That would be like meeting a short-term liability with a long-term obligation. The tax payable is your short-term obligation that you have to fulfil for that particular year.

However, insurance products are of a long-term nature and you may find that though you may have saved the tax for that particular year, you will be paying for it by way of future premiums for many years to come. In any case, with the introduction of the new direct tax code, permanent tax saving will not be any more possible, but more on that next week.

Coming back to our topic, look atinsurance like a life saving pill that is to be administered only when you need it. Otherwise, the side-effects of the pill may be worse than the imaginary disease.

Term insurance

Perhaps one of the best, least-promoted products of the insurance industry is term insurance. It is the most economical and efficient way to insure yourself. Those who find that they need life cover should compare and contrast the term insurance products offered by various insurers and opt for the one that most satisfies their needs.

Term insurance covers the policyholder for a desired number of years against death, accident, disability etc — the same as other policies. In contrast, it does not have any maturity, paid-up, surrender or loan values. On occurrence of the contingency, the beneficiary gets the sum assured but on survival, the insured gets nothing.
In the case of any other policy, with or without bonus, whole life or endowment, actually the return on assurance component is also nil. However, it gets mixed up with the return on the investment component which could be (depending upon the policy) lower than other comparable investment products. Take care of this.

Basically, all insurance policies have term insurance as their base with optional add-ons, allowing the proponent to formulate his own policy, consistent with his personal needs. Each rider has its own premium.

You can choose one or more riders (or none) as add-ons and should undertake a comparative analysis of such riders in the stable of all the insurers for choosing the one that has the best cost-benefit ratio. Some examples of riders are personal accidental death benefit, terminal illness, major surgical assistance, hike in sum assurance, spouse insurance, renew/ convert benefit, etc.

Tax benefits of life insurance

As some cynic said, “There are only two certain things in life. One is death, the other is income-tax.”

In India, death may be certain but income-tax, with its vagaries of rules, is certainly not certain. So let’s briefly examine the tax benefits associated with insurance. For starters, any sum received under a life insurance policy, including the sum allocated by way of bonus is totally exempt from tax under Section 10(10D).

There are 3 exceptions:

Keyman insurance.

Policies covered by Section 80DD.

If the premium paid, in any of the years during the term of the policy, exceeds 20% of the actual sum assured, the maturity value received by the policyholder will be fully taxable. However, any sum received under such policy on the death of a person shall continue to be exempt.

Also, a deduction under Section 80C up to Rs 1 lakh is available on premiums paid on policies in the name of self, spouse or children, major or minor, even married daughters but not parents, whether dependent or not.

Where a taxpayer discontinues an insurance policy before premiums for two years have been paid, the deduction allowed during earlier years shall be withdrawn and shall be deemed to be the income of the year in which the policy is discontinued.

In sum

Without the foundation of insurance, the grandest of the financial planning edifice is only a castle in the air. However, never lose sight of the fact that over-insurance and excessive protection is bad for financial health.

Life insurance is a haven of security, shielding the family against hardships in the event of the demise of the breadwinner. To give an analogy, if your child is ill and requires medicine, you should buy it regardless of its cost. Life insurance is an absolute parallel case in all respects except one. When you do not buy the drug, the suffering of the child is visible. When you do not buy the life cover, you are not there to see the suffering. In either case, the effect is the same.

But the drug should be administered if and only if the child is ill. If taken otherwise, its side-effects could cause untold harm. When your dependents are already well provided for, excess-covering your life has the same effect. You do not fathom the loss but it exists.