Life Insurance : A new perspective.

Life Insurance for long has been synonymous with LIC agent for all of us , specially with the generation of our parents. But buying LIC policies in the name of either insurance or investment is one of the biggest mistakes that one can do to his/her money. Lets show you how it is a bad choice. Purpose behind availing life insurance should be -

“To ensure continuity of life for dependents in case of death of earning member of the family”.

A typical family person earns to suffice following needs -

• Daily expenses of the family
• Education of children
• Marriage of children
• Post retirement expenditure
• To cater various liabilities or lets say EMIs like Home Loan, Auto Loan etc.

So your life insurance should ensure that above needs are taken care of in case of your untimely demise. Though it sounds very simple to break a need in the form of 4-5 parameters, real exercise starts once you start calculating life cover needed to cover above needs. Below is a step by step guide to decide it -

1. Zero Down -
1. Make a list of all your -
1. Liabilities
2. Life-stage events
3. Responsibilities
2. Assume -
1. An average rate of inflation for the rest of your life. Thumb rule says that our generation can safely assume a rate of 5% for rest of our lives
3. Landmarks -
1. Decide time remaining for different life-stage events like marriage, graduation of children etc
4. Ballpoint -
1. Give a ballpoint value to achieve various life-stage needs as per today’s cost
5. Calculate -
1. Calculate the future value of each life-stage event by taking in view the time remaining to achieve them and average rate of inflation
6. Add -
1. Add all your liabilities (outstanding principal of loans) and the value of life stage events calculated in above step.Add a lumpsum amount to the value obtained which you may feel is required to take care of your dependents’ needs for daily expenses.

The value calculated by above process should be your ideal life cover. Now I hope all of you will appreciate that for most of us the value will vary from 1-2 crore. And all this while we felt happy for availing policies that provided cover worth 5-10 lakhs at most

Now coming to investment efficiency , typical returns of LIC policies vary from 5-6 % on an annual basis, after keeping you invested for a period of 15-25 years. Even an FD pays you around 8%. Need I say more?

Now question arises , how to avail sufficient life insurance at least possible cost?

Answer lies in Term Plan.

Below are a some suggestions to decide which plan is best for you -

• Decide tenure for which you will need the life cover. Typically it should cover your major life stage events like marriage and education of children.Don’t go over-board in deciding  tenure as one generally has adequate savings by the time one reaches twilight of one’s life and hopefully that much saving can take of one’s retirement.
• Check latest Claim Settlement Ratio* of various Life Insurance providers. A higher value of Claim Settlement Ratio mitigates chances of rejection of claim in case of one’s untimely demise.
• Compare various plans online by visiting life insurance companies websites and comparison sites like policybazaar.com etc
• Discuss product features with various companies’ representatives so that you get to know pros and cons of various products
• Inquire about features like payment mode, medical test requirement, term of the policy etc.

As life insurance has meant LIC policies for us which come with certain investments also , we have lived through myth that we get life cover for FREE. While in reality we have been paying in terms of very low returns on the money invested in policies. While some may argue that money spent on buying term plan goes waste if I survive through the term of the policy, the fact remains that it provides you “Peace of Mind” for the rest of your life.

So just go ahead and start planning on providing a cover to your family’s needs or ask us if you need any help at healthynivesh@gmail.com. Like our posts, stay tuned to our updates using facebook

You might want to read Why life insurance in detail.

* Claim Settlement Ratio refers to total number of claims settled by an insurance company. The calculation is done by dividing total number of claims settled by the total number of claims settled. For instance, if a life insurance company receives 1000 claims and settles 980, the claim settlement ratio is 98%

Annuity- Healthy retirement Income

We explained impact of compounding in a previous article. There is one related concept called annuity which is critical to understand to plan for 30 years from now. This concept is vital when someone is planning for retirement income (pension) and hence have to be attached to NPS which mandate buying annuity at maturity.

Concept of Annuity is very counterintuitive at short durations but makes a lot of sense in longer term. Let me start by asking a simple question if at the beginning of an year you have 12000 Rs. How much are there for every month? Straight forward answer is 1000. but lets take this to long term. If at the beginning of retirement your corpus is 60 Lakh and you assume a post-retirement life of 20 years how much you can have for every year? I am sure you understand answer is not 3 lakhs (25k per month). You have just more than 6 lakh 30 Thousand (63k per month) per year*. Some of us might be thinking “Why?” and answer of this why is Interest and compounding. A good analogy of this system is like a farm house of chickens (For nitpickers among us, lets assume none of chickens die of natural death and every newborn is equally capable of reproduction. If only biological systems were as simple as financial systems) where you have put some chickens which grow by reproduction and you take few out every month for your household needs. No of chickens you take out are more than what they reproduce, so over a period of time you are going to run out of them. How long does it take before you run out of chickens is dependent on three factors:

1. How many chickens were there initially
2. Reproduction rate
3. How many of them you take out

It may be difficult to model these factors for chickens but it is fairly easy for money and voila!! we have a financial product known as annuity. But this much is not enough, people responsible for managing money know, one size fits all approach do not work and hence they have made several tweaks and named them as different products.

1. Some people want their mension to continue for their lifetime and hence do not want to touch the corpus while living and hand it over to kids after them. So they choose to get only interest as pension while on death the corpus is handed over to kids/relatives

2. Some people might not want to take headache of moving their saving corpus from one product to another at retirement so may choose a single plan which takes care of investment while earning and provide pension after retirement. Bingo this is what traditional pension plans do

* Interest rate 8.75%. Give and take a few thousand based on interest calculation cycle

There are number of options available under the annuity category to cater to different needs and requirement. Like e.g. you may like your dependent to keep getting the full pension once you are not there or may want him/her to get 50% of the pension only after you, to cater to her needs only. Before exploring different kinds of product lets explore features first -

• Immediate or Deferred - If pension starts immediately after the purchase of annuity plan itself, its known as Immediate Annuity. In case annuity payouts (pension) starts after a certain period of annuity purchase or after you keep paying for annuity regularly for a period of time , its known as Deferred Annuity.  

• Return/Non-Return of Capital - Whether the amount used to purchase the annuity is returned to the subscriber after ceasing of pension.

Now lets explore different kinds of Annuities one by one -

1. Annuity for life - you receive pension for rest of your life
2. Annuity for Certain Period - Annuity continues for a certain period decided at the time for subscription of the plan. In case of subscriber’s death in between the period , dependent gets the pension for the rest of the period. After the end of the period, pension ceases.
3. Return of Capital - Purchase price of the annuity is returned to the dependent after death of the subscriber.
4. Increasing Annuity - Pension increases at a certain rate every year
5. Annuity with option for Pension for dependent -
1. 50% Pension - Dependent gets 50% pension after the death of the subscriber
2. 100% Pension - Dependent gets full pension after the death of the subscriber
3. 100% Pension with Return of Capital - Dependent gets full pension after death of subscriber. After death of dependent of the subscriber, anybody nominated by subscriber gets the amount used to purchase the annuity.

Annuity as a product class is still in infant stage as far as India is concerned. Thanks to years of neglect by the government, greater penetration of other alternatives like PPF, absence of focussed marketing by Pension companies and lot many other factors. Pension companies not even disclose rates for different kinds of annuities at public platforms like websites etc. But as India moves towards to the path of a developed nation, Annuity as a product class is bound to grow substantially , as is the norm in developed nations.

More information about different Annuity providers and products can be accessed here.

Bothered about investments? You may like a story narrated by Warren Buffett in his letter to shareholder. Any comments and feedback are highly appreciated here or on facebook

Life Insurance- Your commitment to your loved ones

Death is never a good word even to mention, least of all to mention in first line. But death remains one of the biggest truths and an unavoidable event of our lives. A sudden demise at any stage of life of an earning member can bring havoc to the finances of his/her family. In Indian context where family responsibilities forms an important part of one’s lives, ensuring continuity of lives of family members becomes even more relevant.

Life Insurance basically means a product where your dependent/s (selected by you, generally blood relatives) receives a pre-determined sum of money in case of your death, in return of payment of a sum known as premium.  Life Insurance in India has been for long synonymous with Life Insurance Corporation (LIC) , the mammoth government undertaking. But for last one decade its dominance has been challenged by private players which have successfully made inroads into the still nascent Indian market by innovative products and aggressive sales practices.

Lets begin with terminology of the Life Insurance Industry –

•  Insurer – Life Insurance Company
• Insured – Life Insurance Consumer
• Life Cover – Sum to be paid to dependents of Insured in case of death, by the insurer
• Premium – Sum paid by insured at regular frequency to the insurer , for availing life cover
• Tenure – Period for which Insurance holds good

Life Insurance products can be classified into followed types –

1. Pure Life Insurance Products – One that offers only life insurance as service.
2. Hybrid Life Insurance Products – Products that provide investment as an additional feature of the insurance product.

Even between above categories, insurers these days provide variety of products.

Pure Life Insurance Products -

• Term Plan – Premium paid (generally annually) by the insured goes into covering for cost of life cover provided ONLY.
• E-Term Plan – Term plans sold over internet are known as e-term plans. They generally have lower premiums than one bought offline, as they have lesser sales cost.
• Term Plan with Increasing Cover – these term plans increases life cover at regular intervals at a pre decided rate (in percentage terms of the initial life cover)
• Term Plans with return of premium – this kind of product returns an amount equal to the sum of the premiums paid by the insured at the end of the tenure - in case insured survives the tenure of the product -decided at the time of availing the product.

Insurer ensures returns of the premium by investing a part of the premium in such a manner that it grows into the sum to be returned at the end of the tenure. So insured is basically paying premium to avail life cover in addition to getting all the money paid back. Needless to say these products have higher premiums than pure term plan.

Hybrid Life Insurance Products –

Remember the LIC policies, that inseparable part of our parents’ financial planning? They come under this category only. Hybrid products can be considered as a mix of investment and insurance. Insured person pays a premium which is invested by the insurance company and in case of any fatality, dependent of insured person gets a lumpsum life cover. In case insured person survives the tenure he still gets the same amount. These plans are called as endowment plans. LIC have long been pioneer of plans like these. These plans are very simple but goes against basic principle of personal finance “Insurance is an expense and not investment”. Various research have shown that investors are better off by picking term plans and investing money in other investment avenues than buying endowment plans. But these plans have remained in demand due to simplicity and penetration of LIC sales agents

ULIP’s are another class of hybrid insurance products- ULIP or unit linked insurance plan is market linked* insurance cum investment plan which acts as combination of mutual fund (debt or equity or both)  and insurance. It is one of most integrated financial product which allows investors to decide proportion of money kept in debt and equity, seamless transfer between them, without any tax or penalty implications. It is one of most evolved financial product available for individual investor. Though ULIPs are very simple to buy and take care of most of portfolio requirements, these remains one of complicated products to comprehend for a non savvy investor.  That is why this product constitutes one of the most mis sold products historically but over time regulation have catch up with salespeople and now IRDA have framed well defined guidelines to prevent investor exploitation.

Most of the life insurance products fall under one of these categories with slight variations. Tax treatment of most of the above products is similar with money put in being tax exempt under Section 80(C).**

*Market Linked are those products whose returns depends on the returns of the debt or equity market.

** Life Cover should be at least 10 times of the annual premium for the policy to qualify for Section 80(C) exemption.

If you want to know why it is important to care about money matters please read our post here about importance of financial literacy. If you have any questions please like our fb page or follow us on twitter.

National Pension Scheme : A Tax Exemption or tax deferment

Year after year , pre-budget discussions in media build upon expectations to Taxpayers of higher exemptions and deduction limits, no matter what is the economy scenario and whether govt has manoeuvrability on the same or not. It was no different even this year.Almost all media houses predicted increase in deductions like Section 80(C) and raising of exemption limit. But Finance Minister was more than justified in disappointing the taxpayers owing to the tight fiscal situation.Still he came out with some increments and promised to provide more head-room , as and when fiscal situation improves. Lets have a bird view of his major announcements affecting our Taxation -

1. Exemption on transport allowance for salaried class increased from Rs. 800 per month to Rs. 1,600  per month. It will lead to an increase of Rs.9,600 in deductible income.
2. Exemption limit on health insurance for self and dependents have been increased to Rs. 25,000 from Rs.15,000. In most cases a family of 4 gets a health insurance of 5 lakh for about Rs.15,000, so very difficult to make use of this increase.
3. A new exemption of Rs.50,000 have been proposed for investment in National Pension Scheme under section 80CCD(1). This exemption is in addition to 1.5 lakh exemption already available for investment under Section 80(C) instruments, listed here
4. Wealth tax have been abolished. I hope most of us will not know that we were liable to pay tax on movable and immovable assets worth over 30 lakhs.But this rule won't be there anymore.
5. Govt will reintroduce tax free infrastructure bonds. Interest on these long term bonds will be exempted from income tax. Details are awaited on the same.

Out of the above features, its the National Pension Scheme (NPS) which has generated the maximum curiosity, as till now it was overshadowed by other alternates available under Section 80(C). Below is an analysis of the same -

What it is ?

It is a pension product being managed by professional fund houses appointed by Central Govt. Presently five fund houses (ICICI Prudential, Kotak, Reliance, SBI, UTI) are licensed to manage NPS.

Where does it invest ?

NPS is a diversified instrument having exposure to

• NIFTY stocks ONLY - In the ratio of their contribution to NIFTY Index
• Corporate Bonds - Debt instruments issued by corporates
• Government Securities - Debt instruments issued by central and state govts
• 
  

One has to declare his allocation of contribution among above fund categories.But equity exposure is limited upto 50% of the contribution only, i.e. one can allocate upto half of contribution to equity funds only.

You can also give the asset allocation discretion to the fund house, in which case they will allocate it as per your Lifestage needs, like e.g. those at younger age will have more exposure towards equity than those nearer to retirement phase.  

All five fund houses licensed for NPS have their respective funds under each of the three categories.

An NPS subscriber can choose only one fund house for all the three categories.

Fund House	Equity Fund	Corporate Bond Fund	Govt. Sec Fund
SBI Pension Fund	14.06%	11.88%	10.57%
UTI Retirement Solutions	13.78%	11.50%	10.20%
ICICI Pru Pension Fund	13.47%	11.36%	9.97%
Kotak Pension Fund	13.46%	10.85%	9.83%
Reliance Pension Fund	13.08%	10.41%	9.80%

Annualised Returns for Last Five Years for Different NPS Schemes Available

What are rules of Maturity or Withdrawal ?

NPS has a COMPULSORY provision of availing annuity out of total withdrawable corpus.There are two ways of withdrawal of the corpus -

1. When investor turns 60 - He/She needs to buy an annuity with at least 40% of the withdrawable corpus.
2. Before investor turns 60 - He/She needs to buy an annuity with at least 80% of the withdrawable corpus.

Rest of the amount can be withdrawn subject to applicable taxation as mentioned below.

What is Taxation ?

Apart from 1.5 lakhs exemption available under Section 80(C), NPS provides an additional Rs.50,000 exemption under Section 80CCD(1).

Additionally there is another limitless exemption under Section 80CCD(1B) where upto 10% of your basic and dearness allowance - contributed by your employer to NPS account in your name - becomes Tax free.

One can also replace Employee provident Fund contribution by NPS , but rules and guidelines for the same are still awaited.

But currently NPS comes under Exempt Exempt Taxed (EET) category, which means that even though investments upto applicable limits and interest or gain earned is Tax free , total corpus at the time of withdrawal becomes taxable. So , it practically means that it is more of TAX DEFERMENT instrument. You don't pay tax today but you will have to pay tax at the time of maturity on the total investments plus all the gains made.

To summarise following are the set of Pros and Cons -

Pros -

1. Additional Tax Exemption
2. Allocation across debt and equity instruments
3. Option of switching among Fund Houses

Cons -

1. Compulsory Annuity
2. Tax on the full withdrawal amount*
3. Equity allocation limited to 50%

While additional exemption may look tempting , but one should not invest in NPS for the purpose of availing tax benefit only. Decision to invest or not invest should be taken after a holistic consideration of all factors related to NPS and one’s need only.

* Experts believe that in future Govt will exempt withdrawal amount from tax according to global standards

We have made a list of all other exemptions available under section 80 C here. Let us know what do you think about this blog in comments or by writing to us on healthynivesh@gmail.com

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