By CFP Poonam Rungta
As a thumb rule, financial planner and investment advisors recommend term insurance for appropriate risk cover for full-proof financial planning. Indeed, it’s the right scientific approach for effective financial planning to meet the family’s financial goals in all probabilities.
If term insurance is the answer to risk cover, what are the so-called traditional plans and ULIPs? Well, here is the answer to that.
Before recommending financial planning to an individual, risk profiling is a must. Risk profiling means to gauge the investor’s appetite to absorb the long/short term losses.
Psychometric questionnaires are used to assess the risk profile of an individual. The questionnaires comprise queries on day-to-day situations. Generally, the individual taking the test is told to choose one option that best describes his response to the situation and the multiple options provided along with the question. The answers help the financial planners and wealth managers’ judge how the individual will react in a given situation.
That forms the basis of the individual’s ability to take risks. The questionnaires thus minimize the probability of any biases being introduced by wealth managers in the financial-planning process. An individual taking the test should be honest while answering the extent that he should select an option that best describes him and not the one he thinks is the right option. Financial planning is done to ensure peace of mind, and hence it is essential to understand your personality to ensure that you get what you want.
Risk profile categorizes the individuals in various segments such as conservative, moderate or aggressive. Once you have categorized and measured risk exposure, the last step in the process requires us to consider the choices we can make in dealing with each type of risk. There is a whole range of options for products available for every kind of category. Insurance is one such product that can be used against hedging risk and can be positioned in the portfolio for returns in each of these categories.
Insurance is primarily bought for 2 reasons:
1)Risk of dying too early
2)Risk of living too long
Term plan, which gives the high-risk cover for a low premium, takes care of the first reason. It takes care of the needs of the family with an appropriate risk cover.
The second reason is also a part of retirement planning and needs equal importance in your planning. Conservative investors prefer the traditional plans of insurance companies for retirement planning. Insurance products not only provide risk cover but are tax effective too. The premium paid towards insurance gets benefit u/s 80C of Income Tax Act. Additionally, the policy’s returns on maturity are tax-free under Section 10 (10) D of the Income Tax Act. Though the liquidity is not easy, loans are available on such investments. At the same time, the policy can also be used as collateral securities through the assignment.
Returns of such plans are conservative. Investment strategies of insurance companies are closely guarded and monitored by IRDA. Under the authorities’ stringent guidance, the investment of insurance premium is invested in various pre-decided avenues. There is a cap in equity investment. The premium of traditional plans is especially invested in government securities; hence, the returns are just like debt markets. Therefore, traditional insurance plans can be included in the portfolio and positioned as a debt product.
Whole life plans of insurance companies are perfect for taking care of the risk of living too long. Tenure of term plans should be till the working years of an individual. Post-retirement from work, the whole life
take over and provide permanent protection for dependents while building a policy owner’s cash value account.
With this type of insurance, the insurance company manages the policies of various accounts. It pays a death benefit to the beneficiary named and offers low-risk, tax-free cash accumulation. These plans allow the death benefit varying with the cash value account’s fund returns. It provides for borrowing from the policy during the policy lifetime. There is no guarantee on the cash value.
But its important to buy such a plan at the start of the career. The bonus rates of whole plans are maximum. Hence longer the tenure, higher the returns. So accrued bonus can be withdrawn as loan in the retirement period.
In the financial plan, insurance is included in the portfolio for high-risk cover, and hence the emphasis is on term plan only. But if the investor is of the conservative profile, then insurance products like endowment plans, limited premium payment plans, money back plans etc. can also be included in the portfolio and an exclusive insurance portfolio can be made. The maturity of insurance products being tax-free scores over pension products which are not that tax sufficient.
The premium paid of pension products enjoy section 80C of the Income Tax Act, but the pension received is included in the income and taxed according to the income slab. The early you start building your insurance portfolio better it is. The investment gets a long time to mature and develop a healthy retirement corpus for you. The investor should be aware of the effect of inflation in meeting financial needs. If insurance is bought as an investment product, then the choice of insurance products should be such that the returns beat the inflation and the financial goals can be achieved without any gaps.
