What is the Role of Life Insurance in Financial Planning?

So imagine you’re driving home from work one day when suddenly, another car rams into yours. Fortunately, everyone comes out unscathed, but your car needs some costly repairs. Thankfully, your auto insurance steps in, sparing you the burden of tapping into your savings to cover the hefty mechanic bills. You breathe a sigh of relief and move on. 

Now, let’s take a moment to ponder a more sombre possibility: What if that accident had resulted in something far more serious? Do you have the life insurance coverage necessary to ensure the financial well-being of your loved ones? You can’t do anything about unexpected events such as this one, except prepare for them beforehand. 

Financial Planning is incomplete without proper life insurance planning. Most people think of it just as a safety net for themselves and their families but fail to consider that it can help them with much more. In this blog, we will see how life insurance can be a viable investment option and a tool that helps you secure your future.

Understanding Life Insurance

Simply put, a life insurance policy is like an agreement between you and an insurance company. As the policyholder, you make regular payments to your insurance company, which are called premiums. In return, the company promises that if something happens to you and you pass away, they’ll give a lump sum of money to the people you nominate, known as your beneficiaries. This lump sum is called the death benefit.

This simple fact its highlights the importance of life insurance planning in your overall financial plan, but there are other ways it can benefit you as well –  especially in terms of your investment planning, as in the case of Unit Linked Insurance Plans.

Importance of Life Insurance in Financial Planning

Now let’s look into detail how life insurance can be a versatile tool for you:

Protection for your loved one

One of the main purposes of life insurance is to give your family a financial safety net. If you happen to be the main earner of your family, your untimely demise could leave them very vulnerable. A life insurance policy can help pay for funeral costs and daily living expenses for your loved ones, allowing them to maintain their standard of living. It can also cover any big bills, mortgages, or debts you might leave behind and keep your family on course to reach their life goals. 

Investing in plans such as Unit Linked Insurance Plans, can help you with your retirement planning. ULIPs come with the double benefit of insurance coverage and a guaranteed sum if you outlast the term of the policy. When you pay your policy premiums, some of the money goes into the investment you prefer, and the rest is set aside to cover insurance. So, it’s not just about protection – it’s also a way to grow your money and work towards your financial goals. 

Tax Benefits of Life Insurance

Life insurance can also give you tax benefits, making it a crucial part of tax planning. Under Section 80C of the Income Tax Act, any premiums you pay towards life insurance policies are eligible for tax deductions. This deduction can help reduce your overall tax liability, freeing up more of your income for savings and other financial goals. This isn’t just it –  the death benefit that your beneficiaries receive is also tax-free which makes life insurance an efficient way to pass on wealth to your family without incurring heavy tax burdens.

Income Replacement

Life insurance also serves as an income replacement tool as it provides a steady stream of funds to your family in case of your demise. They can receive this money in the form of regular payouts or it can also be structured to replace a certain portion of your income. This income replacement function is very important and helps your family and loved ones maintain their lifestyle, as it also takes into account inflation and the increasing financial demands of your family over time.

Debt and Liability Management

If you leave behind any debts like mortgages, loans, etc. it can be really hard for your loved ones to pay them off, especially if you are the main breadwinner of your family. Life insurance can be used to clear any outstanding debts and spare your family a massive burden. On top of that, it can also protect any assets or properties associated with the liabilities, for example, your family won’t have to sell off their home to clear any debt.

Estate Planning

Making a plan for what happens to your money, property, and other assets after your demise is estate planning. It’s about deciding who should get what and how much, how they should get it, and when they get it. It makes sure that your wishes are followed and can also help your loved ones avoid legal and financial hassles over the inheritance.

With a life insurance policy, you can make sure that your assets go to the right people as per your wishes, and this avoids complications and delays that can occur without proper planning. It can also help reduce the tax bill as life insurance money can be used to cover estate taxes, which means your loved ones can inherit your belongings without having to sell them to pay those taxes.

Benefits of Life Insurance Investment

• Making a life insurance investment at a young age can help you get lower premiums. This is because when you are young you have fewer health issues and a longer life expectancy. Thus the insurance companies consider younger individuals to be lower risk. You can lock in a policy at a younger age and secure lower premium rates for the entire duration of the policy, which will save you some money in the long run.
• A person can have many financial liabilities such as education loans and home loans. A life insurance policy can make sure your family does not bear the burden of these debts in your absence.
• Some life insurance policies help you generate income after retirement. These retirement plans can help you maintain your standard of living during your golden years.
• Life insurance offers tax deductions of up to Rs. 1.5 lakh under Section 80C of the IT Act. If you add a health-based rider plan with your insurance, you can also enjoy health insurance benefits of up to Rs. 25 thousand under Section 80D.
• Life insurance like ULIPs offers free fund switches to policyholders, which can help you reallocate your investments among different fund options without having to pay any additional charges. This flexibility is unique to ULIPs and enables you to adapt to changing market conditions, risk tolerance, or financial goals over time.
• Annuity plans can help you secure a stress-free retirement.
• Knowing that your family’s financial needs are met in case something unfortunate happens will allow you to rest easy.
• Insurance plans that offer a guaranteed sum assured can protect your money’s value from inflation, market fluctuations, and economic uncertainties.
• You can borrow against your policy’s cash value to finance large and unexpected expenses.

Types of Life Insurance Policies

A life insurance policy doesn’t just provide a payout after the policyholder’s death. Various types of insurance policies offer a range of benefits while the policyholder is still alive. These include investment opportunities, guaranteed returns, tax advantages, and flexibility to help you meet different life goals and needs. 

These types of life insurance policies have their own features and benefits and are suited to different individual circumstances.

• Term life insurance – These are the most popular and most common types of life insurance policies. They provide financial coverage for a specific period of time, like 10, 20, or 30 years, and the beneficiaries only get the sum assured if the policyholder passes away during the term of the policy. The premiums are low which makes them very affordable, especially to young people. There is no investment component in term insurance policies, which is why they are also called pure protection plans.
• Whole life insurance – As the name suggests, whole life insurance financially covers your loved ones for the rest of your life. This type of policy is particularly suitable for individuals with dependents such as special needs children or a non-working spouse, who rely heavily on the policyholder’s income and cannot support themselves financially in their absence. These policies have a savings component called cash value which builds up over time and can be used to borrow against. Generally, these policies last for 99 years.
• Universal life insurance – This is also a kind of permanent life insurance like whole life insurance, but the key difference is that universal life insurance policies give policyholders more flexibility in premium payments and the savings component of the policy.
• Variable life insurance – This policy also includes a cash value component which you can invest in assets like mutual funds, stocks, or bonds. Variable life policies tend to have high premiums and come with higher risks compared to other types of life insurance. This makes them suitable for individuals who are comfortable with investment risks and are looking to grow their policy’s cash value.

Life Insurance as an Investment

Here are seven reasons why having a life insurance investment is a smart move:

• A life insurance policy acts as a financial safety net for your loved ones. In case of any unfortunate event, life insurance makes sure your family can maintain their lifestyle and don’t fall under the heavy burden of debt. This remains the most important reason why a life insurance policy is a wise investment. If you have many dependent family members such as young children, elderly parents, or a non-working spouse, investment advisor services can help you navigate through the options and choose the right life insurance policy for your needs..
• A Unit Linked Insurance Plan (ULIP) is a type of vehicle that combines investment with insurance. With ULIPs, your premium is divided into two parts. The first provides insurance coverage and the second is used for investing in various mutual funds such as equity, debt, or hybrid funds. You can choose which fund to invest in based on your financial goals and risk tolerance, and you are allowed to freely switch between different investment funds. Upon maturity, you receive the fund value.
• Insurance with a built-in investment component can help you achieve your long-term financial goals by providing a dual benefit of protection and wealth accumulation. 
• Policies such as whole life insurance can be used to accumulate cash value over time which can be accessed during your lifetime for various financial needs. You can borrow against the cash value of the policy through policy loans, or withdraw cash from the cash value.
• The government offers many tax benefits for investing in a life insurance policy. Under Section 80C of the Income Tax Act, you can claim a deduction of up to Rs. 1.5 lakh every year for life insurance premiums paid towards policies covering yourself, your spouse, and your children. Also, under Section 10 (10D), the maturity proceeds of life insurance policies are exempt from tax.
• Because you need to pay regular premiums to keep your life insurance policy active, it helps you develop a savings habit that benefits you in the long term. This kind of discipline is essential for financial success.
• Lastly, having an insurance policy gives you peace of mind. Knowing that in case of your premature demise, your family’s financial needs will be taken care of can fill you up with a sense of security.

Mistakes to Avoid When Buying Life Insurance

The fate of the insurance companies has grown post-covid. After the pandemic, you can see a different new world. Many breadwinners of the family succumbed to the virus, leaving their families in dismay. However, COVID-19 was successful in creating awareness about the life insurance industry. According to the Economic Times, during the pandemic, 51% of respondents bought life insurance out of which 30% were first-time buyers. This rate is rising, but most people buy the product in haste so that it costs them wrongly. Before this happens to you, catch some common mistakes that people make when it comes to buying life insurance:

1. Not buying early

A common belief is that “I’m perfectly fit today, so why spend money on getting life insurance?” Secondly, many people end up procrastinating on buying early. The fact that these people miss on is “Low premiums”. Yes! The younger you are the premiums on a term insurance plan are low & locking it, when the rates are low, is a sensible thing to do. However, the pandemic has somehow dispelled such misconceived notions.

2. Hiding critical details

When it comes to buying life insurance or health insurance, many people end up not disclosing their critical information at the time of buying the policy. Critical information could be anything from hiding pre-existing illnesses to habits of engaging in smoking, drinking, etc. All this information should be expressed at the time of purchasing the policy. At that time, you might become successful in hiding critical information, but unfortunately, during the claim process, you will end up facing rejection.

Insurance companies are very particular when it comes to the process of claim. They cross-check every minor detail present in your policy and compare them with your claim details. So, if you wish to have a smooth claim process then make sure you don’t hide any important information.

3. Buying the policy for a very short-term

Leaving a good financial cushion for the family after them is what every breadwinner wishes for. For instance, buying the cover for the age of 45-50 years will leave no major financial assistance for your family. Ideally, you should have enough coverage that cover all your obligations & pay off debts. In the 40s & 50s for most individuals expenses like a child’s higher education or marriage-related expenses are at the peak.

Thus, the sudden demise of the breadwinner in this critical period may leave the family exposed. Therefore it is highly unlikely that within a 4-5 years span, you would have accumulated enough assets for your family to lean on by this time. Thus, don’t purchase the policy for a very short tenure!

4. Going for return of premium

One irrational thought that people arrive at is ‘Why should I go for it when I don’t get the premiums back? Thus, to clear this thought, insurance providers came with a ‘return of premium’. Under this, if you survived the entire term, your premium will be returned to you. Now, this seems like a wonderful deal, but unfortunately, it is NOT! Now consider you have term cover of 1 crore that costs you somewhere around 13,448* annually but if you opt for the same policy with ‘return of premium’ then it will cost you 28590* per year. The premium amount goes higher as per the normal policy without the ‘return of premium’. Secondly, people also fail to understand that when the premium is returned after say 20 years, the amount nearly loses its value due to inflation.

If you are someone paying 25,000 annually then you get up to 5 lakhs by the end of the 20th year assuming 7% inflation every year. Thus, to this small amount back, you might end up paying inflated premiums for the 20 years.

5. Getting insurance in the name of the child

This mistake is majorly made by the grandparents when they buy/purchase the policy for their grandchild. A recent example to explain this was there was a grandmother who had her whole life insurance under the name of her 6-year-old & it started to mature when the grandchild turned 99.

Many insurance companies might suggest you this option but think twice before making this mistake. This is because life insurance is only a cover that secures the family, financially after you. Therefore, a child doesn’t need insurance here, so be wise enough to make a decision.

6. Not informing your family about the policy

Many people believe that informing anyone in the family might not be a good idea. However, if you are not anymore then who will be a responsible person to take care of this? No one! You wouldn’t such a situation to arise, right? Well, an extremely trustworthy & responsible person should be made aware of this. Sometimes in life, the right decisions are the toughest to make, but again, you have to, for your family’s financial security.

Conclusion

As you can see, adding life insurance to your overall financial plan is not only beneficial but also a responsible thing to do. If your family depends solely on you for income, life insurance is almost a necessity. It can make sure that in your absence your spouse, children, or parents are not left vulnerable and protect them from life’s uncertainties.

The life insurance policy you buy should align with your financial strategy. It should take into account your assets, debts, desired portfolio returns, goals, and risk tolerance. Consulting a Financial Planner can be a wise decision in crafting an insurance plan that syncs with your specific needs. By doing so, you can have peace of mind knowing that both your financial future and your family’s future are well protected.

FAQS

What role does life insurance play in managing financial risks?

Life insurance helps manage financial risks by providing a safety net for your family in case of your untimely demise. It ensures financial stability by covering expenses like loans, education, and daily living costs, preventing financial hardships for dependents.

Why is life insurance important in financial planning?

Life insurance is crucial in financial planning as it offers financial security, tax benefits, and long-term savings options. It helps achieve life goals, such as retirement planning and wealth creation, while protecting loved ones from unforeseen financial burdens.

What factors should be considered when choosing life insurance for financial planning?

Key factors include your financial goals, coverage amount, policy tenure, premium affordability, type of insurance (term, whole, or ULIP), and additional benefits like riders. It’s also important to assess the insurer’s claim settlement ratio and reputation.