There are some people who are looking for the cheapest life insurance policy to fulfil their protection need. However, at the same time, there are people who like to invest the maximum fund in the insurance schemes.
When posed with the question why, they simply reply more investment means more returns.
The question here is- is it prudent enough to invest out-of-the-limit in insurance schemes, even if these schemes belong to unit-linked category?
The simple answer is no.
Insurance is not an investment tool exactly
The core purpose of having any insurance is to have protection against contingencies. To offer the financial protection, insurance companies are charging some amount out of the premium as fee and the rest of the amount is utilized for creating the pool of funds to protect those in need. To do this, insurers have various kinds of propositions so that every person interested in insuring himself is able to find a plan that suits his financial state.
Initially, plans were largely traditional in nature that offered guaranteed minimum returns over a period. Many people did not find this idea of insurance lucrative enough and preferred other investment tools to earn comparatively higher profit. So the insurers came up with ULIPs that is unit-linked insurance plans, to be able to give better returns or market-linked returns to customers. The basic fundamental of providing protection remained the same.
Take inflation into consideration to understand whether it is right to over-spend
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To better understand the concept, take inflation into consideration and calculate the financial returns you would get over the period. Would the returns received be considerable enough to fulfil at least some of your needs?
No. You find that you would basically be using your own funds that get added to the small percentage of profit your investments are able to accumulate over a period of time. Saying that does not imply that insurance is of no use.
It is just that the system of insurance works to provide you much-needed, timely protection that you would not be able to avail by yourself. So, it always makes sense to have insurance, but one should not over-spend on it to have huge returns.
How should you decide whether you are over-spending?
There are many general rules that insurance dealers follow to make buyers understand the estimate of their needs. The basic question is- how much life insurance you really need?
To check what you are spending is enough or more than what you are required to spend, read and calculate the recommended sum insured.
Insurance equal to ten times your annual income. For instance, you earn Rs. 10, 00,000 annually you should buy coverage of Rs. 100, 00,000.
Insurance equal to 5 times your annual income plus total liabilities. If total liabilities are Rs. 70, 00,000 and annual income is Rs. 10, 00, 000. Estimate comes to Rs. 1, 20, 00, 000, that is Rs. 50, 00,000 (510, 00,000) plus Rs. 70, 00,000.
Insurance equal to 300 times your monthly expenditure. Say you spend Rs. 50,000 per month, your coverage should be equal to Rs. 1, 50,00, 000 (50,000300).
Insurance equal to the amount your family needs. Family needs do not remain constant for a long time. The expenditure today can increase tomorrow if kids pursue higher studies.
If your children are in their earning phase of life, expenditure may not increase, rather decrease. Like this, take an estimate of various needs on a yearly basis that are not in a scene in the present but need could crop up after some years.
Earning phase of life
Add up the immediate liabilities surfacing at the event of demise and what your family will need for ongoing needs for the number of years you would like to protect them financially.
By using the above methods you get rough estimates about how much sum insured you should have.
If one of these estimates matches with the collective sum insured of all your life insurance policies with a difference of even a few thousands of rupees, you are on the right track.
However, if the collective amount of the sum insured of your policies is much more than these estimates, you need to look into the matter.
Neither it pays to be underinsured nor does it pay to be over-insured. Assuming an insurance plan as an investment plan is fine to a certain extent as it offers tax benefits and keeps your financial goals in place but allocating maximum funds there is not a wise decision.
By investing more than what is required you are converting your investment into expenditure.
To extract maximum value out of your money, invest in insurance only what is required and the difference can be used somewhere else to maximize the returns.
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