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Monday, April 22, 2013

Five tips to ensure you buy the right insurance cover

Though saving tax is not the primary purpose of insurance, it is still bought for this benefit. Find out the questions you should ask in order to buy the appropriate cover.

1) Do you understand the plan?

Before you purchase an insurance plan, be very clear about the benefits it offers. Tax deduction under Section 80C should not be the only reason for buying it because you can achieve this through other tax-saving investments as well. Go for it only if you understand the features of the plan, including the tenure, payouts, premium amount and surrender rules, and how it fits in with your needs. Don't buy if the plan is too complicated for you.

Agents usually want to push you into buying the scheme at the first meeting. Take your time and compare the product with others in the market before buying it.

2) How much is the cover?

The premium paid for a life insurance policy is eligible for deduction under Section 80C and any income accruing from the scheme is tax-free under Section 10 (10D). However, last year's Budget altered the rules significantly.

To be eligible for these tax benefits, a life insurance policy must offer a cover of at least 10 times the annual premium. If the cover is not big enough, there will be no tax deduction under Section 80C and the maturity amount will also be taxable. There is no need to panic if your existing policy does not make the cut. This applies only to regular premium policies issued after 1 April 2012.

3) What is the tenure?

The tenure of the policy is almost as important as the cover. An insurance policy will not be able to generate meaningful returns if the tenure is less than 10 years. Even if the market does well, a Ulip will barely break even in 3-4 years.

In traditional policies, a 15-year term will hardly yield 4-5% returns. If you are looking for a higher return, buy for at least 20-25 years. This will also ensure that you have an insurance cover in your middle age, when the need for life cover is at its peak. However, keep in mind that traditional insurance plans don't give adequate cover. Ideally, one should have a cover that is at least 5-6 times one's annual income.
 4) What are the risks?

A Ulip is a market-linked instrument and the equity option carries the same risk as any equity mutual fund. Investing a large amount at one go through a Ulip is risky, especially if you are buying a single premium policy.

It is best to invest through monthly or quarterly premium options, but this option may not be open if you are planning to invest before 31 March. What you can do is put your money in the debt option instead of the equity fund. You can then shift small amounts to the equity option every month or so. Most insurance firms allow 10-12 switches free of charge in a year. This strategy of gradually shifting to equity can also be used if you already have a Ulip.

5) Do benefits match needs?

Insurance plans offer a wide range of benefits. Some give periodic payouts, others give a lump sum on maturity; some allow equity exposure, while others give a dual insurance cover. Not all benefits are suitable for all investors. For instance, a young person with a steady job and rising income will not benefit much from a money-back plan that gives periodic payouts.

A child plan will not be of much help if your son is already in his teens and you need money for his college education 4-5 years later. Similarly, a low-yield endowment plan that offers minimal cover may not suit a person who needs to insure himself for a sizeable amount. 
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