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Life Insurance

Life is unpredictable. Things may not always go as we had planned. Though life teaches us to deal with adversities, prior contingency planning can reduce stress considerably as we go through difficult times. Insurance is a financial product which protects the policyholder from a financial loss caused by an unexpected event. Insurance can give you / your family financial protection in adverse situations e.g. death, accident, serious illness, damage to your property, vehicle etc. Broadly, there are two types of insurance - life insurance and non-life insurance. Let us discuss life insurance first.

Life insurance is financial product that provides the policyholder financial protection in the event of an unfortunate death. Anyone who is working and has dependents like children, spouse, retired parents etc needs life insurance because an untimely death will deprive the family of income and cause financial distress. If you have debt e.g. home loan, car loan etc, then life insurance becomes an even more critical financial need.

How does life insurance plan work?

A life insurance policy will provide your dependents financial protection over a certain period of time (the policy term) in the event of an unfortunate death. The amount of financial protection is known as sum assured or cover; sum assured is the amount your dependents will get in the event of an unfortunate death during the policy term.

How much cover should you buy?

It depends on your income and the needs of your family. The income from your life insurance cover should be able to meet the needs of your dependents for a long period of time or at least till the time, when your dependents themselves become financially independent e.g. your children start working. Additionally, if you have debt e.g. personal loan, home loan etc your cover should be large enough to repay those loans in the event of an unfortunate death. A common rule of thumb is that your life insurance sum assured (cover) should be at least 10 to 12 times of your annual income.

What is the cost of a life insurance policy?

The cost of an insurance policy is known as premium. The insurance premium is payable annual (or other intervals like monthly, quarterly etc) throughout the policy term or a shorter period, as specified in the policy document. There are also single premium policies, where the entire premium is paid up front. Since the entire premium is up front (lump sum), the insurer will provide you a discount on the premium. The insurance premium will depend on a number of factors, the most important of which are the sum assured, your age, pre-existing medical conditions (e.g. diabetes, hypertension etc), lifestyle habits (e.g. smoking), additional riders e.g. accident, critical illness etc.

Different types of life insurance plans

There are broadly three types of life insurance plans:-

Term life insurance: Term life insurance provides life cover to the policy holder over the policy term. Term plans are pure protection plans; there are no survival benefits in term plans. For example, if you bought an Rs 1 crore term plan for a policy term of 20 years, your dependents will get the sum assured i.e. Rs 1 crore in the event of an unfortunate death. However, you will not get any maturity benefits, if you survive the policy term. The premiums of term plans are much lower than premiums of other types of life insurance plans.

Traditional life insurance plans: The main difference between traditional life insurance plan and term plan is survival benefits. In a traditional life insurance plan, you will get the sum assured if you survive the policy term. In addition to the sum assured purchased by you, you will also get guaranteed additions to the sum assured every year, after the completion of a specified number of policy years. You will also get reversionary bonuses at the discretion of the insurer. Traditional life insurance plans are insurance cum investment plans, where you get the life insurance cover in the event of an unfortunate death and also returns on your investment (premiums) at the end of the policy term, if you survive the policy term.
There are different types of traditional life insurance plans. Whole of life plan provides life insurance cover for entire life or up to 100 years, whichever is less. On death of the policyholder, the nominees will get the sum assured and bonuses. Endowment plans gives the insured a sum assured, guaranteed additions and bonus amount on maturity. Money back plans returns a percentage of the sum assured at some regular intervals e.g. if you buy a 20 year money back plan, the insurer may pay you 25% of your sum assured after every 5 years. The premiums of traditional life insurance plans are much higher than term plans. The benefit of traditional life insurance plans is that you can get higher tax savings (life insurance premiums are eligible for deduction from taxable income under Section 80C) and tax free returns.

Unit Linked Insurance Plans: Unit linked insurance plans (ULIPs) are insurance cum investment plans. The main difference between ULIPs and traditional life insurance plans is that ULIPs are market linked investments. In ULIPs a portion of your premium is used to provide you life insurance cover, while a portion of your premium is invested in market securities like stocks, bonds etc. You can think of ULIP as a combined Term Life Insurance Plan and Mutual Fund. Since ULIPs are subject to market risks, you can even make a loss in ULIP. However, ULIPs also have the potential of giving much higher returns than traditional life insurance plans. There are different types of ULIPs with different risk profiles. Your insurance advisors can help you select a plan according to your risk appetite.

Taxation of Life Insurance Plans

Tax payers can claim deductions of up to Rs 1.5 lakhs every year from their gross taxable income by investing in various schemes allowed in Section 80C of Income Tax Act. Life insurance premiums, whether they are for term plans, traditional life insurance plans or ULIPs, qualify for 80C deductions. The maturity proceeds of life insurance plans are tax free, as long as the premiums paid do not exceed 10% of the sum assured for policies issued after 1 April 2012. Maturity benefits for premiums exceeding 10% of sum assured will be taxable as per the income tax rate of the investor.

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