Financial planning can seem like a daunting task sometimes. Where does one begin? What are the factors one must consider? Which financial instruments must one buy? Financial planning is a pre-requisite to a secured future life – it brings a structure and sense of certainty to your life. It is therefore extremely critical to living a financially stable life.
The first step to financial planning is always defining your goals and understand how the financial products you are considering can help you fulfil those goals. When you look at financial planning from this lens, it will seem much simpler in practice than it does in theory. Among the key asset classes to be considered in financial planning is life insurance. In this article, I will primarily delve into how this instrument can help you fulfil your and your family’s future goals and aspirations.
I have observed that a large number of people don’t consider life insurance purchase when planning their finances and are often unprotected from unprecedented life events. They believe that their accumulated wealth can weather them through the rocky roads and keep their future aspirations intact. However, that may not be the best approach to financial planning.
When advising people on financial planning, I always recommend the pyramid approach: a safety net makes the foundation of your financial pyramid, accumulating wealth forms the middle layer, and retirement as well as legacy planning the peak. Now, break down each layer further by identifying the goals that you want to plan for, and you will find it easier to identify the products you need in your financial portfolio.
If you notice, the foundation of your financial pyramid is a safety net and that’s where insurance comes in. Insurance serves the specific need for income replacement or for tiding you financially through unforeseen events like an extended illness. When you have security, i.e. insurance products in your financial portfolio, your accumulated wealth also stays protected from any sudden dents. Did you know that most Indians pay out of pocket for health-related expenses? A 2021 data by Azim Premji University shows that the Covid 19 pandemic pushed an additional 230 million people into poverty.
So, now that we know why financial protection products are critical to have in one’s financial portfolio, let’s understand how one can go about buying a life insurance plan.
a. When should one buy a life insurance plan?
I always recommend buying a life insurance as soon as one has started their first job. Apart from the protection aspect, insurance also helps instil a habit of saving from an early age, which makes way for prudent financial practices in the longer term.
b. How does one determine if they need insurance and what are the factors to consider?
Term insurance is the purest form of protection and anyone who has dependents must opt for it.
Several factors go into consideration when buying term insurance including income, expenses, liabilities, inflation rate, etc. There are tools available online that can help you determine required coverage for you, depending on your unique requirements.
The general thumb rule is that the life cover must be at least 10 times your current income. In my experience, 10 times coverage is rarely adequate for individuals, and therefore one must figure out the multiple applicable to them by doing a thorough study of their existing and future liabilities. As your liabilities increase, your cover should increase too.
c. Key factors to look at when choosing a life insurance company
While choosing a life insurer is important, it is much more critical to identify the right product. First, shortlist the product you want to buy and then determine if the company offering it has robust fundamentals. It is crucial to look at indicators like claim settlement ratio, returns on funds managed by the company, IRR, charges applicable on the products, reversionary bonuses announced in the past, company performance, etc.
d. Precautions to ensure your dependents receive the intended benefits
A life insurance policy serves as a promise that gets fulfilled at a later date and in your absence. It is critical that you ensure that you completely disclose all relevant details to your insurer. Details about income and education, occupation, health (including pre-existing diseases), family history and habits such as smoking, and drinking should be divulged upfront. If all the facts are disclosed truthfully when purchasing the policy, then chances are your dependents will experience a hassle-free claim.
Don’t blindly follow the recommendation of a friend or a relative. Let them guide you but ensure that the decision you make is based on your research and understanding.
e. Different types of life insurance products to consider
Life insurance offers varied solutions aimed at fulfilling different life goals. Term insurance and critical illness solutions are among key protection products that offer you financial immunity from events like loss of life or diagnosis of serious ailments. There are also wealth accumulation products like endowment or market-linked policies which help people not only save their money but also grow their wealth for longer-term goals like a child’s education. Income solutions offer a fool-proof method of creating an alternate or second source of income for people across age groups. Similarly pension and annuity products enable are an ideal method for retirement planning.
While financial planning can seem like a tedious task, it is important that you spend time and undertake this exercise. While it may be cumbersome today, it will ensure a smooth sailing financial life going forward. While advisors are certainly well-placed to help you, they can only advice what they believe is ideal for you. It is important that you personally take charge of your own finances. So, happy financial planning!
Views expressed above are the author’s own.
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