As we approach the end of the financial year, we are being bombarded with messages on TV, radio and newspapers to buy Life Insurance to save taxes. But, are tax savings the right reason to buy insurance? Absolutely not! In fact, we think that to buy an insurance policy for tax saving purposes is one of the worst personal finance mistakes that one can make.
Life Insurance is an instrument to protect your assets and family in case the worst happens to you. During your life or during the term of the policy you pay a premium to the insurance company. In return, the insurance company is contractually obliged to make a payment to you or your survivors upon the occurrence of a negative event or after a fixed period of time. The amount of payment, known as the sum assured, should be enough to cover all your liabilities so that your survivors are not inconvenienced, they do not suffer a lower standard of living or face the prospect of financial ruin.
So essentially the sum assured should be a function of whatever existing liabilities you might have incurred, and which still have to be honoured whether you are around or not. This puts all the financial risk on your surviving family members. For instance, lets say you are the only breadwinner in the family and there are two ongoing liabilities: a car loan outstanding that needs to be paid back within the next three years and monthly rent for the apartment that you and your family occupy under a two year lease. If something happens to you then there will no longer be any regular income coming into the household. This could result in a disastrous situation where your survivors might have no money to pay the monthly EMI on the car loan you took, and might not have to a recurring source of money pay rent so that they can continue to live in the apartment.
No one wants a situation where the car might be re-possessed and the family might be forced to vacate their home because of lack of funds.
Yet, this is what could happen if you buy life insurance without paying any regard to what the sum assured should be. Hopefully, by now you are beginning to understand why it is wrong to buy insurance only for tax savings. Just getting a tax saving on Rs. 1 lakh is not good enough. You need to make sure that the insurance coverage that you get is sufficient to cover all your financial liabilities. Buy insurance so that you have the right amount of sum assured that gives your family the payoff that allows them to cover all the liabilities and financial needs without compromising their lifestyle, in case you are no longer there.
Lets take an example to understand this. Amit Singh is 31 years old software engineer working at an MNC. He is married, has a four-year-old daughter and is the only breadwinner in the family which includes support for his retired parents. He has a the following financial obligations and liabilities:
As you can see, Amit’s total financial obligations are Rs. 1 crore.
Since joining the workforce at age 24, he has bought an insurance policy every year to save taxes. The sum assured that these policies give him is Rs. 10 lakhs. He has no other savings or assets. Amit is currently paying a cumulative premium of Rs. 1 lakh across all these policies. With seven policies, he feels he has enough insurance and feels secure.
The mistake that Amit has made is that despite having seven policies, he still does not have adequate coverage. If something happens to him, his family needs Rs. 1 crore, but all Amit has planned for is Rs. 10 lakhs. He bought insurance for the wrong reasons, i.e., to save taxes, without really analyzing whether he was getting suitable and adequate coverage. Further, if he was aware that he needs to protect his family up to Rs 1 crore, he could have achieved this through buying a term insurance policy with an annual premium of Rs. 40,000 that would give him Rs. 1 crore of coverage.
The lesson for all of us is that be careful to buy insurance for the right reason. Verify that you end up getting the right kind of coverage, and if you can get a tax advantage then that is a good incidental benefit to enjoy.
RAVINDRABAGRA said :
|Very useful guidelines and more useful tips for choosing Life Insurance Policy.|