Personal Finance: Here’s why you should not go for insurance products only to save taxes

As a thumb rule, the coverage should be at least 10-20 times your current annual income, which might help pay off your home loan and fund your child’s education, among others.

Going without a cover is not just financially risky, it’s also expensive.

As we approach the tax-saving seasons, many Indians undoubtedly would look to buy life and health insurance. Often, it’s because it seems the quick, convenient way to save taxes. But, two things often go wrong with such hurried purchases. One, the coverage may be inadequate. Two, the long-term returns might seem unappetising, and you’re stuck with having to make lump-sum premium payments on an instrument that pays poorly. While tax-saving is a legitimate reason to buy life and health insurance, it shouldn’t be the deciding factor. Let’s examine four thoughts before you make your tax-saving purchase for the year.

Understand coverage needs

Firstly, a life or a health insurance must protect you from financial harm. It is important that you take the time to understand how much life insurance your family might need after your untimely death. As a thumb rule, the coverage should be at least 10-20 times your current annual income, which might help pay off your home loan, fund your child’s education, and provide an income to your spouse. Similarly, your health insurance should be at good enough to cover the costs of hospitalisation or treatment of a critical illness such as cancer. Without insuring up to this basic level, you are putting your family at risk. Your family’s money requirement in death or illness is something you must calculate before buying insurance.

Maintain your cover

India has low insurance persistency ratio – basically, the ratio of people who renew their policies in a year. As per IRDA statistics for the top four life insurance companies in India, only 70.57 per cent of policies were renewed in the 13th month, 52 per cent in the 37th month, and 36 per cent in the 61st month. Simply put, 64 per cent of customers did not renew their policies after five years. Many choose to exit their policy after securing their tax savings. Going without a cover is not just financially risky, it’s also expensive. An insurance policy is a long-term commitment. Buying new policies at later stages in life would not only be more expensive but more challenging as your health gets poorer with age. Basically, buy your policies young and maintain them.

Don’t just insure; also create wealth

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Of the many smart money moves you can make, tax-saving is only one. It’s important to not just insure, but also invest to create wealth and achieve life goals. For best results, insurance and investment should be done separately. ULIPs and endowment plans aren’t the only way to generate wealth. You can also do so through a host of other options, the most attractive of which are mutual funds – especially ELSS funds which not only create tax-free wealth but also save taxes. At the start of the new financial year, you can start an SIP with a five-star rated ELSS fund, and stagger your contributions over the whole year instead of making a lump sum tax-saving purchase at the end of the year. With falling interest rates across board, the discerning investor is looking for tax-saver instruments that can provide higher returns. ELSS funds, with their low lock-in of three years, could be a great way to combine tax-saving and wealth creation today.

Term plans cost little

It’s essential to insure yourself. So if you’re in the market for a life insurance policy, buy a term plan first. This is especially important when you have dependents. Term plans are pure insurance products with no investment benefit. Therefore, the premiums are low and the life cover in comparison to other life insurance products can also be bigger. As you incur a low premium cost, your savings are freed up to be diverted to attractive investment options such as ELSS funds.