Insurance + Investment + Tax = Bad Combination

Source – CNBC TV18

WE live in a world of combinations (or combos)! Inspired by the McDonald's way of life where we buy fantastic combo meals of burger + Pepsi + fries, we seem to want everything in the combo format. And why not? It's great value for money.

We could follow this mantra for other purchases as well. Life insurance for instance. Marketers have made us believe that we are buying great value for money when we buy life insurance as a device for protection + investment + tax.

But hold on a minute! Our approach to buying junk food cannot possibly be the same as our approach to buying security for our family!

Talk to any financial expert and the first thing he will tell you is you should never buy insurance for investments or to save tax. Buy insurance only to insure yourself and to give your dependents financial freedom and security.

Don't mix insurance and tax

The tax-saving spiel is particularly over done because under section 80C of the Income Tax Act the premium on your policy is deductible. Statistics reveal that on an average 30% of annual premiums of life insurance companies come in the month of March. This is a clear indication of the fact that people buy insurance to save tax.

Tax should probably be the last consideration while buying life insurance. Amount of life insurance that a person requires should depend on his income level, total expenditure, the number of dependents and debts outstanding but definitely not the tax to be saved.

Shailesh, 35, has a taxable salary income of Rs 5 lakh (Rs 500,000) per annum. His tax saving instruments till date included investments in provident fund, postal savings and pension policy of up to Rs 75,000.

Lured by the buzz that insurance marketers have created about insurance and tax saving, he now wants to invest up to Rs 25,000 towards premium of an endowment policy. He congratulates himself for his smart move -- getting insurance cover and tax saving together!

For that kind of premium, the maximum sum insured that he gets is Rs 5 lakh. The million-dollar question is -- Is that enough to support his dependents in the unfortunate case of his death?

Shaliesh has a monthly expenditure of Rs 10,000 and an EMI of Rs 7,000 on his home loan. Current value of his other investments is Rs 8 lakh (800,000). Now at an assumed inflation rate of 6%, rough calculations estimate that he would need an insurance of at least Rs 33 lakh (Rs 3.3 million).

Make the right move

So what should Shailesh have done instead?

It's simple: Only a pure risk cover term policy can offer him such a large cover at a low rate of premium. He could have paid just Rs 10,000 per annum and got himself a cover worth Rs 33 lakh. Since this is not an investment product, the premium will be expensed and he will not get any returns on it. But his prime motive has been amply served.

Of course, this doesn't mean that all combo's are bad. In fact, the Maharaja Mac Combo Meal at Mac Donald's is a particularly good deal and tasty as hell. But that's where the combo mania should stop!