Avoid These Six Common Life Insurance Mistakes

Avoid These Six Common Life Insurance Mistakes - Life insurance is one of the most crucial elements of anyone's financial plan. However, there are many misconceptions concerning life insurance, mainly because of how these products have been marketed and sold in India over the years. We've discussed some frequent errors that people buying insurance policies should avoid.

1. Underestimating the need for insurance 

Many life insurance purchasers base their decision on the insurance coverage they want, the amount of the sum assured on the plans their brokers want to market, and their ability to pay the premiums. This strategy is incorrect. Your financial situation determines the type of insurance you need; it has nothing to do with the goods on the market. A standard guideline for coverage among insurance customers is ten times annual income. According to some financial advisors, a cover of 10 times your yearly pay is sufficient because it will give your family ten years' worth of support after you pass away. However, this is not always the case. Say you have a home loan or mortgage that is 20 years long. When the loan is still in default after ten years, how will your family pay the EMIs? Let's say you have young children. When your children most need money, such as for their higher education, your family will run out of money. Insurance purchasers must consider several criteria when determining how much insurance coverage is appropriate for them.

Repayment of the policyholder's total outstanding debt, including home, auto, and other loans.

After debts are paid off, the cover or amount assured should have extra money to satisfy all of the policyholder's dependents' monthly living needs while accounting for inflation.

After paying off debt and providing a monthly income, the sum promised should also be sufficient to cover the policyholder's future commitments, such as paying for the education and marriage of their children.

2. Choosing the least expensive policy

Many insurance consumers purchase less costly plans. This is another grave error. An inexpensive policy is useless if the insurance provider cannot pay the claim in the case of premature death for some reason. Even if the insurer pays the share, the insured's family is not likely to want to stay in that scenario if it takes a lengthy time. If such a tragic event occurs, you should pick an insurer that will uphold its duty to honor your claim promptly by comparing parameters like claims settlement ratio and duration-wise settlement of death claims of various life insurance companies. The IRDA annual report contains data on these indicators for all insurance companies in India (on the IRDA website). Additionally, it would help if you looked up internet reviews of claim settlement services before selecting a business with a solid track record of handling claims.

3. Purchasing the incorrect plan and using life insurance as an investment

The most widespread myth regarding life insurance is that it may be used for retirement planning or as an intelligent investment. This misunderstanding is primarily the result of some insurance brokers who enjoy pushing pricey plans to earn high commissions. Life insurance does not make financial sense as an investment when returns are compared to those of other investment options. Equity is the best wealth development tool for young investors with a long time horizon. With the same investment, investing in equity funds through a SIP over 20 years will provide a corpus at least three or four times the maturity value of a life insurance plan with a 20-year term. Always consider life insurance to protect your loved ones in the unfortunate event of your passing. Investment should be seen as a distinct factor. Unit Linked Insurance Plans (ULIPs) are attractive investment products that insurance companies market, but you should separate the insurance component from the investment component for your evaluation. You should also pay close attention to how much your premium is spent on investments. Only a tiny portion of initial ULIP insurance is used to purchase units.

A competent financial advisor will always suggest that you purchase term insurance. The most basic type of insurance is a term plan, a plain insurance contract. Term insurance plans have far lower premiums than other insurance plans and give policyholders a more significant investible surplus than endowment or money-back plans, which they can use to buy investment products like mutual funds that have much better long-term returns. If you have term insurance, you may add other insurance policies (like ULIPs, endowment plans, or money-back plans) to your term policy in certain circumstances to meet your individual financial needs.

4. Purchasing insurance for tax planning purposes

For many years, agents have cajoled their customers into purchasing insurance policies to benefit from Section 80C of the Income Tax Act and reduce their tax liability. Investors must understand that insurance is likely the worst option for tax savings. The return on insurance plans is between 5 and 6%, but the Public Provident Fund, another 80C investment, offers returns that are about 9% and free of risk and taxes. Another 80C investment that provides higher long-term tax-free returns is equity-linked savings schemes. Additionally, insurance plan returns might not be completely tax-free. The maturity funds are taxed if the premiums exceed 20% of the amount insured. As previously explained, life insurance aims to provide life insurance; it is not to produce the best investment return.

5. Giving up on a life insurance policy or withdrawing money from it before it matures

This is a grave error that jeopardizes your family's financial stability in the case of an unpleasant event. It is best to wait to use life insurance till the unlucky covered person passes away. Some policyholders sell their policies to cover an immediate financial need with the intention of purchasing new ones once their economic condition has improved. These policyholders must keep in mind two points. First, nobody has control over mortality. That is the primary reason we purchase life insurance. Second, as the insurance buyer ages, life insurance becomes quite expensive. Your financial plan should include contingency funds to cover unforeseen urgent expenses or offer liquidity for a while in a financial emergency.

6. Purchasing insurance is a one-time endeavor

I'm reminded of a television commercial for an old motorcycle that ended with the phrase, "Fill it, shut it, forget it." Some insurance customers approach life insurance with the same mentality. They believe that their life insurance demands are met for all time after they purchase appropriate coverage in a reliable life insurance plan from a reputable business. This is incorrect. Insurance buyers' financial circumstances evolve. Take a look at your revenue now and ten years ago. Your income hasn't doubled or tripled, has it? Additionally, your way of living would have substantially improved. If you purchased a life insurance policy based on your income ten years ago, the sum assured would not be sufficient to support your family's current standard of living in the tragic event of your untimely demise. To cover that risk, you should get an additional term plan. The need for life insurance must be reviewed regularly, and any other sum that may be necessary should be purchased.

Conclusion

Investors should steer clear of these typical errors when purchasing insurance coverage. Life insurance is one of the most crucial elements of anyone's financial plan. Therefore, life insurance needs to be given careful thinking. Insurance customers should use caution when dealing with the dubious selling tactics used in the life insurance sector. To make the best choices for life insurance and investments, working with a financial planner who examines your complete portfolio of investments and insurance on a holistic basis is always helpful.

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