Broadly there are two types of life insurance plans – Term and Traditional
Deciding on the correct life insurance plan depends on various factors like long-term or short-term planning, age, number of dependents, investment requirements, etc. Life insurance being an important aspect of financial planning needs market research and understanding of the terms and conditions of various policies.
Life insurance, in simple terms, means a certain sum called premium that an individual pays for his mortality to ensure financial security for his beneficiaries. Over the years, insurance policies have taken various forms and types. But the most common ones still remain the traditional and term insurance. Let us have a look at these two plans in detail.
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Term Insurance or pure life insurance gives a substantial death benefit at a fixed annual premium amount over a specified time period. In case of the death of the insured during the period, the coverage amount goes to the beneficiary. However, if the insured person stays alive till the full term of the policy, then he has to forego the coverage and may have to purchase further coverage, albeit with different rates and conditions.
Since a term plan does not have any survival or maturity returns and in the most of the cases, it lapses before the death of the insured, many people view it as an empty investment. But it certainly makes an intelligent investment for any of the following reasons:
- You want high risk coverage at lower costs.
- You are a bachelor, but have dependents, especially disabled ones.
- You are a married person with children.
- You have a home loan liability.
The term insurance policy term is usually between 5 – 30 years. So, an individual prefers to buy this policy around the age of 25-45 years. Once he is in mid – 50s, he may want to discontinue with the policy as by that time other traditional investment tools start yielding returns and most of the EMIs are over. Hence, his overall financial liability reduces, which makes his family members easier to meet life expenses in his case of his death.
Traditional Insurance, also known as whole life insurance, money back or endowment insurance, provides multiple benefits like risk cover, fixed income returns, safety and tax benefit. These are the oldest and the most basic model of insurance and are beneficial for people with low risk patterns. They provide a sum assured and a guaranteed or a vested bonus at maturity.
You should consider taking a traditional insurance plan under any of the following circumstance:
- You are looking for a long term financial stability.
- You want risk coverage as well as guaranteed returns on your premiums.
- You already have high income, but you are not savings savvy.
- You want cash flow for predictable future life events such as a child’s education & marriage and retirement.
- You are a conservative investor.
- You are exclusively looking for higher tax saving instruments.
A traditional insurance policy works on the 90/10 rule, which means that the insurance company can retain only 1/10 of the profits and the rest of it would be shared with the customers. This means higher returns on the investment for a customer. The investment risk is entirely borne by the company, making it a risk-free option for the risk-averse customers.
Even if the returns from a life insurance fails to beat the growing inflation rates, the sum assured and bonus amount received will be enough to meet certain expected expenses. Taking a traditional insurance will ensure you peace of mind. If you are a passive investor or looking for more tax saving instruments, traditional insurance could be a good asset for you.
So, Which is a Smarter Choice?
Now, having weighed the pros and cons of both plans, the big question still remains: which one to buy? Actually, the choice depends on your financial goals and needs.
Here is an example to substantiate it.
A 30 year old non smoking male can insure himself for Rs 1 crore sum assured by paying Rs 10,000 premium for 30 years under a term plan. The maturity amount as well as the return here is zero. Whereas, if he is taking an endowment traditional plan for a sum assured of Rs 25 lakhs, he will have to pay around Rs 30,000 or maybe even higher premium. But here, he will get at least assured returns of 5-7%, after considering the tax saved, maturity amount and guaranteed bonus.
However, the returns in traditional plans are nullified, looking at the administrative and surrender costs. Moreover, the death cover is not sufficient to meet the life’s uncertainties. Until and unless, you have a secured, stable or another source of income to support your loved ones after your death, a traditional plan is not recommended. It is also argued that there is no transparency in how the traditional policy premium is being parked by the insurance company. In fact, a fixed deposit would be a better investment than a traditional plan. Buy a traditional plan, only if you are looking for assured cash flow at regular investments to meet expected expenses.
Taking a term plan makes more sense, if you are looking for pure protection. Experts also suggest a combination of term insurance, equities and mutual funds in your investment portfolio to fetch better returns, balance your wealth and diversify the risk. Taking the example above, after paying for the term plan premium, you can invest the balance amount in mutual funds, which can give you about 10-15% returns. So, you get the best of both worlds – pure life cover as well as good returns.
The Last Word
While choosing an insurance plan, bear in mind how much life coverage you are looking for, how much money do you need to carry your expected financial obligations and whether the chosen policy will align with your long term financial goals.