Right insurance policy will not only protect your life or important assets but also helps in strengthening personal financial plan. In this article, we will discuss different type of insurance plans and policies that can help you to include it into your portfolio to be risk free.
Before we start lets us understand what is insurance policy in simple terms
What is insurance policy
Insurance is transfer of risk from one entity to another in exchange of certain payments called premium. Policy holders receives a contract, called Bond which has details of the terms and conditions under which he or she will be compensated in future for the risk that has covered by paying periodic premiums.
In India, we take insurance policy as an investment where as its much more. It should be looked as a risk mitigation tool.
You need to strike a balance between the risk covered and investment return in your portfolio. Every policy has something special to offer; either at low risk and low return or high risk and higher return.
Generally insurance policies are created with following objectives:
- Creation of wealth
- Saving for a specific Purpose like retirement, child education etc
- To cover your Risks like death or financial loss
Priority of having an insurance policy starts from the bottom i.e. first you should buy a policy to cover up the risks like death. Then the next objectives will follow. This means one should first consider life policies to cover risks like death or financial loss before considering it for investment. This time of policy where you cover your death based on your income or earnings is popularly known as term plan.
Insurer are also offering combination of the above objects like ULIP which has both insurance and investment coverage.
You need to avoid suggestions from agents as they force you to buy those policies which are irrelevant for you but agents can make a good profit out of it. An agent generally gets 30-40% commission from a traditional policy in comparison to a ULIP policy of 8-12%.
Types of insurance policy
Now let us understand type of insurance policy that one can avail in India and abroad. These policies are divided into two broad head;
- Life Insurance
- General Insurance
An contract that is signed to pays out a sum of money either on the death of the insured person or after a set of period is called a life insurance policy.
Under this type of policy, the insurer company promises to pay a designated amount upon the death of the insured person or after a certain period. The insured person or the policy holder pays a premium periodically for it.
Not everyone needs insurance policy but if your dependent or closed relatives is dependent on your income then to cover the mortgage or other living expenses, you need to have it. It will help your dependents in getting a lump sum or regular payments if you die.
Life insurances contracts tend to fall under two major categories;
- Protection policy / Term plan
- Investment Policy / Endowment plan
Also Read: When and why you need life insurance
Other policies which do not protect risk on life are comes under the category of General Insurance. These policies are to protect the risk of your Health, Vehicle, Accident, Property and Liabilities.
Type of Life Insurance Plans
Term plan protects the risk of your early death for a particular term or period such as 10, 15, 20 or 25 years. It does not have any investment component in it. It only extends guaranteed level of premiums and a specific amount of coverage for a specific period of time.
These term plans do not offer any maturity benefit at the end of the term.This means, nominee will get full sum assured only when the insured person dies during the policy term or period.
Now, term plans have become very popular due to reduction in premium rates and advertising the by insurer.
At a young age, if you take a term plan then you pay a lesser amount as premium in comparison to what you pay when you start the insurance policy at an old age. So the sooner is better.
While buying a term plan one should consider following factors;
- Find out the value you should cover based on your income and future debts.
- It should cover you till your retirement.
- Try to cover your life at an early age.
Please remember, a term plan will only pay out when you die. If you don’t earn for your family because of illness or disability then you are not covered.
Endowment Plan / Money Back Policy
On your death, if term plan is active then insurer company provides the nominee with a corpus that can replace the income or financial loss.
If you are looking for an insurance plan which will give you return on maturity and also covers life risk then go for endowment plan.
It helps you to invest at a low risk with a low return. Most people take it as an investment measure. Endowment plans can offer you return between 5-6% per year with low risk coverage.
Investing into these wealth plans provides high return of your investment but is highly risky. ULIP comes under this plan.
If you have a life insurance policy then the premium amount paid during the year is eligible for tax deduction U/S 80C of Income Tax Act up to a maximum amount of Rs. 1, 50, 000.
To get eligible for tax deduction, the insurance policies should be in the name of self, spouse or children. If a HUF is making an investment then the policy should be in the name of any members of the HUF.
Section 10 (10D) of the income tax act also states that any income from a life insurance policy is tax free if it fulfill certain conditions of the said section. Before choosing any of these plans we should look into the cost-benefit ratio and the coverage that we need.