An untimely demise of the bread winner causes emotional & financial loss to the dependents. Emotional loss cannot be covered by any means however, financial loss can be covered by taking a term life insurance. Term life insurance is a product that pays out a lump-sum amount to dependents of income earner post his demise. It works as a financial cushion for the dependents of income earner.
We have discussed about basics of term life insurance, who should buy term life insurance & when you one buy it in our previous post: Consider these 3 parameters carefully before buying life insurance
Do check it out before reading this post.
In this post, we are going to discuss about choosing the policy term & premium paying term of term life insurance.
How to choose policy term
Insurance companies in India offer term insurance policies up to the age of 99 years. This might sound great because it is almost sure that we won't survive till that age. Even if we do, that in itself will be an achievement to be happy about. However, that's not how one should plan about buying term insurance. As we have already discussed that term insurance is a risk mitigation tool rather than an investment avenue. Your goal to take a term insurance should be to protect your dependents from any unfortunate event. If you live long enough and plan your investments in order to achieve your goals then you won't need a term insurance after certain age or after achieving your goals. One should match the time horizon of goals with the policy term of life insurance to keep it simple.
Let's try to understand this with help of an example:
Mr. Aakash (aged 30 years) has planned an investment for his child education that he would need after 15 years from now, he believes he would need at least Rs. 50,00,000 for the education & he also has an existing home loan of Rs. 65,00,000 which has a duration of 20 years from now. He has been doing SIP in mutual funds for his child education & is also paying monthly instalment on the home loan. He can match these goals with the policy term for buying the term insurance. He can buy a term insurance of Rs. 50,00,000 with a policy term of 15 years, this will almost guarantee Rs. 50,00,000 after 15 years either from the investment value if he is around or from insurance claim in case of his untimely demise. After 15 years, if Aakash is around, he won't need this policy as his investments would be worth Rs. 50,00,000 & hence the policy will expire on its own.
Similarly in case of home loan, he can take a policy of equivalent amount and keep the policy term that matches with loan duration & cover the risk.
When you buy a policy for such low durations, the premiums are also very low & do not create a financial burden on you. Our mindset should be to reduce risk rather than earning money from insurance policy.
In above case, a term insurance policy for Rs. 65 Lakhs for a term of 20 years would cost Rs. 8,791 per annum. This is a very low cost to secure a very large amount of loan.
Let's discuss about the concept of premium paying term: Insurance companies offer a flexibility of paying premiums for the policy based on your convenience. You can pay the premiums each year till the duration of your policy or you can pay them in advance. You get a discount on paying premiums in advance based on how quickly you pay up your premium.
Following table gives you a view of how premiums look for various terms:
Mr. A, aged 30 wants to take insurance till the age of 65 years for Rs. 1,00,00,000.
|Premium Paying Term (PPT)||Premium||Total Premium||NPV @ 6%|
|Single premium||₹ 2,75,000||₹ 2,75,000||₹ 2,75,000|
|5 PPT||₹ 62,228||₹ 3,11,140||₹ 2,62,127|
|10 PPT||₹ 35,296||₹ 3,52,960||₹ 2,59,782|
|15 PPT||₹ 27,698||₹ 4,15,470||₹ 2,69,010|
|Regular premium (35 PPT)||₹ 15,995||₹ 5,59,825||₹ 2,31,899|
We have assumed that our money will be invested at 6% to calculate which option is better. From above calculation, we can see that it would be better to go with regular premium option as that has lowest Net present value of our money. This could differ for premiums of different insurance companies. We have taken premiums of HDFC Life Insurance Company for our calculations.
There is no thumb rule to follow a particular approach of premium paying term. One can premium limited paying term in case your business income is non-linear unlike salary. Also one should consult the insurance advisor or financial advisor to get the NPV calculation before going ahead with the decision.
Tip: For an insurance policy term of 20 years or above, one should consider regular payment option & invest the differential amount in an equity oriented mutual fund scheme as the duration of investment would be above 20 years, there are fair chances of generating returns higher than 6%. However, nothing is fixed when you invest in equity oriented schemes, hence you should consult your financial advisor before taking a call on this.
CA Rohit J. Gyanchandani is Managing Director, Nandi Nivesh Private Limited, A Pune based Wealth Management Company.