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They got it wrong, you shouldn’t follow

by Money Puzzle   ·  June 22, 2019   ·  

They got it wrong, you shouldn’t follow

by Money Puzzle   ·  June 22, 2019   ·  

The ‘Gen’ lines are a bit blurry in my mind – where does X end, and Y begin? I’ve been told Gen X are those born in the 60s and 70s mainly. Gen Y on the other hand begins from 1982 (yeah, don’t ask why not 1981).

Why are we discussing Gen X and Gen Y? To showcase an aspect of financial behaviour that ruled the roost as far as the Gen X was concerned and emphatically tell GenY (and Gen Z, albeit a bit early for them) to stay clear of it.

What is this behaviour I speak of? It relates to how insurance was embraced by them.

Gen X eagerly lapped up traditional insurance policies, endowments, money backs and then later unit linked policies. This choice of insurance policies, case after case, has eaten into their financial reserves rather than providing the expected benefit. Whether you blame the misdirected packaging and marketing for these insurance products, or the reluctance of the buyer to ask the right questions topped with the eagerness to simply trust the agent, fact is many Gen X now in their 40s or 50s are laden with useless insurance policies, paying premiums that do little more than burning a hole in their wallets.

The hope is that Gen Y and after them Gen Z (birth years from 1995-2010) will not fall for this investment façade in the garb of protection that traditional life insurance policies sell and will increasingly make better choices through term life insurance plans.

Not worth your time? Too young to think about insurance? No dependents? No funds? Think again.

It doesn’t cost as much as you think

Insurance becomes a costly affair when you seek some return of capital and gains from what you are paying as a premium. As soon as you expect returns, it becomes insurance sold as an investment. When the two get mixed together, charges tend to be high, especially where the return is assured or guaranteed.

Plus, let’s just say that traditional plans tend to make traditional investments in a bid to assure returns – hence, you really shouldn’t hope for high returns. The outcome is low return and eventual unaffordability of premium for the investor, because too many policies have been taken with the wrong perception of building wealth. The high premiums keep stacking up, making it unaffordable.

But, hold on a minute – we are here talking about insurance and not investment. The distinction is important, although rarely communicated.

An investment helps you create wealth by multiplying return. An insurance policy on the other hand, is a contingency plan for those who depend on your income, in the event of your untimely death.

What you need from an insurance policy is a payout that covers at least a few years of annual income that will no longer be available for your family, in case of your death and nothing more. It doesn’t mean that you only have insurance and no investments, it means that bundling the two is not recommended. Do both, but keep it separate.

In other words, what you need is a pure term life insurance policy which caters to the contingency we spoke above rather than any other insurance linked plan that also promises return. Additionally, have a portfolio of financial investments that can help you build long term wealth.

Here is the math.

Do you know, for a 30-year-old healthy woman, a term life insurance policy with a sum assured of ₹1 crore costs between ₹7000 to ₹20,000 per year depending on the life insurer and the policy you pick. There are many available in the ₹7000-₹11,000 range with features like premium waiver in the event of permanent disability and early claim where it’s a case of terminal illness. If you are a 30-year-old man, the cost of this policy is goes up marginally by ₹1000-2000 in a year.

At 25, you are still a bit too young to start thinking of death, and a quick check shows that premiums don’t drop significantly if you take a life insurance policy at 25 years rather than 30 years. If you are married at an early age, then it’s worth considering even at 25. But by the time you are 30, it’s a must to be comparing term life insurance plans and premiums, married or not.

Why start so early?

Simply because it costs less. Let’s say you are not married at 30 but by the time to complete 40 years you are not only married but have one child too. The realisation that insurance is important hits you now and you opt for term life insurance policy. Premium for a similar policy discussed above at the age of 40 will be at least 80%-100% higher. Double the cost.

It is important to see your life insurance cover as something that evolves with significant changes in your earnings. This is not a one-time affair. As your income and number of dependents grow, you will have to keep on adding to your life insurance cover. However, with each passing year, as age adds on so does the mortality cost and hence, insurance premiums are higher when you are older.

There is no harm done in spending just ₹10,000 a year or ₹833 per month for a ₹1 crore cover at the age of 30, to build the foundation of your life insurance sum assured for years to come.

Why not traditional plans

We already spoke about traditional plans being an inefficient use of your money. The premiums are too high, sum assured is low compared to what you can get with a term plan and returns are dismal; various calculations have shown a return of 4%-5% for such products. Sample this: for a guaranteed return policy (endowment policy) that gives you an annual income for a period of 25 years of around ₹62,000 per year, you will contribute about ₹60,000 as premium each year for ten years. The total benefit at the end of term will be around ₹21 lakhs. The death benefit to your family if you were to have an untimely death can be anywhere from a couple of lakhs to a maximum of ₹60 lakhs.

You don’t have to calculate the internal return on this to understand that you are not creating any wealth. Isn’t it better to pay roughly ₹2,00,000 for 20 years and get a much higher sum assured that will actually benefit your family?

Essentially, any insurance policy that gives you all your premiums back, with some return, over a period of 20 years is giving you a very low return. You don’t see it because of the way the policy is structured, not to mention the various conditions attached.

What about Unit Linked Policies or ULIPs

ULIPs are not the same as traditional policies. ULIPs take your premium and invest in market linked securities, which helps you earn better returns. Returns are market linked and not guaranteed; hence cost is lower. The newest variants even offer return of mortality charges included in the costs at maturity of the policy. Their popularity has shot up recently as ULIP returns continue to remain tax free, but return from other market linked equity financial products now have long term capital gains tax to contend with.

Are they worth it? Not yet.

You still have the problem of a low sum assured (death benefit).Although, in the event of death, the fund value also comes to your dependents; however, you don’t have any control over this and if death strikes in the first few years of having taken this plan, your fund value is unlikely to be much.

Moreover, if say your insurance fund manager for the ULIP plan is not performing well, you have to surrender the policy and shift to another provider. Which you can’t do for the first five years as it is locked in. It’s not a simple switch.

You have to go through the entire process of check-ups and documentation for the new policy.

ULIPs are simply not as flexible as other market linked investments. Yes, there is the benefit of having your ULIP proceeds tax free as compared to the 10% (plus) capital gains tax on other market linked investments.

What should you do?

Coming back to where we started – be wiser and learn from the mistakes of the generation before yours’. Insurance is a contingency plan, pay the least and get the highest cover. The contingency is your untimely death, the beneficiaries are members of your family.

In the hope to get back your money paid for premiums don’t make the mistake of clubbing investment with insurance, it will always yield lower than if you separate the two. Take a term plan for the contingency of death and invest separately in pure investment products like mutual funds, stocks, deposits and bonds. All of them are likely to contribute much better towards wealth creation than an investment plan in the garb of insurance.

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