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A dummy's guide to life insurance

April 01, 2017 08:00 IST

Naval Goel explains all that you wanted to know about life insurance but didn't know who to ask

Illustration: Uttam Ghosh/

Life insurance, for years, has remained a mystery to many. However with rapid growth of internet services, more and more people are becoming aware about the benefits of having a life insurance policy.

For millions of people in India, the concept of life insurance still remains a mystery. There are certain fundamentals that you should keep in mind while going for a life insurance product.

What is meant by life insurance?

Life insurance simply covers the risk of life.

Life insurance policy as the name signifies is a contract between the insured person and the life insurance company to provide a pre-assured, pre-determined amount of insurance money to the nominee/s in case of death of the insured or the policyholder.

Life insurance provides financial security to the dependents of a policy holder. The insured amount should be sufficient to replace the income of policy holder.

How much amount would be sufficient?

Determining the amount of sum insured is the trickiest part for most people. However, as a thumb rule, the amount of insurance should be 8-10 times of the annual income of the policy holder.

For instance, if one’s income is Rs 3 lakh a year, then the amount of insurance coverage should be in the range of Rs 30-40 lakh, or more. This way, in case of the death of the policy holder, her/his dependents can invest the sum received in the form of insurance amount in government bonds or bank fixed deposits, and earn an interest at the rate of 9-12 per cent.

The income derived from interest can thus replace the income of the policy holder in case of her/his demise.

However, keeping in mind the average rate of inflation at 5-6 per cent, ideally the amount of insurance should be higher than 10 times one’s annual income.

The income from investment of insurance amount should support the nominees in utilising the same for education, marriage and other necessary expenditure.

The basic purpose is to ensure financial security for the people who depend on the income of policy holder.

Types of life insurance

In India, life insurance is broadly categorised into four types. Here is an overview of all of them:

1. Term insurance policy

Under this type of insurance policy, one is expected to pay premium amount against consideration of a certain sum of insurance coverage.

The amount of premium is treated as expenditure as a term insurance plan does not give any returns or money back.

Term insurance plans can be taken for a period ranging from 5 to 30 years. After the reforms in the insurance sector in India, the premium rates for term insurance plans have gone low thereby making it more affordable than before

2. Endowment policy

Under an endowment policy, the policy holder receives whole of her/his money paid as premium amount back after expiry of a pre-determined policy period.

In case of death of policy holder, his or her nominee receives the full sum insured under the plan.

These kinds of policies are typical and generate returns in the range of 4-7 per cent. They are suitable for people who do not want to take much of risks and look for secured investments in government securities and debt instruments.

3. Unit Linked Insurance Plan (ULIPs)

As the term suggests, Unit Linked Insurance Plans (ULIPs) are purchased in units. The price per unit is announced by an insurance company as per the Net Asset Value (NAV), which is declared every day.

ULIPs provide the dual benefit of life insurance and investment.

The amount of premium paid towards a life insurance plan is investment in equity markets, which works on the principle of risk and rewards. These type of policies generate better returns as compared to other types of plans, in the long term.

4. Group insurance policy

As the name suggests, such policies are taken for a group of people.

Generally, organisations provide group insurance policy benefits to their employees. It depends on a company whether or not it charges employees to contribute towards group insurance scheme.

Are there any additional benefits also?

In India, there are hardly any public social security schemes for masses. Thus, one has to organise financial security from his or her own resources.

Keeping this in mind, the government has come up with mass insurance schemes but the amount is limited to a couple of lakh at the most. This amount may be good but not sufficient to secure financial future of one’s family.

Perhaps, the government also knows that it is not doing enough for its citizens. Thus, there are some great incentives at one’s disposal when it comes to buying life insurance.

Income tax benefits can be availed by those who buy insurance.

An investment of up to Rs 1.50 lakh in life insurance is eligible for claiming tax exemption under section 80C of the Income Tax Act 2000.

That means, if your taxable income is Rs 8 lakh, and supposing that you buy life insurance of Rs 1.50 lakh, then your total taxable incomes goes down to Rs 6.50 lakh.

This way, you are able to directly save income tax in the range of 10-30 per cent, depending on your gross taxable income. One can factor in this tax saving as return generated over the premium.

If you are willing to invest a large amount, you can also consider buying more than one plan for yourself. This can provide you benefits of diversification because if one plan does not generate much return, then there are chances that the other one performs better.

Overall, by buying life insurance, one can ensure peace of mind and get the satisfaction of discharging her/his duties towards family members. 

Naval Goel