Tips to Buy Insurance

While dealing with a loss of a family member is painful enough, not having money or need to figure out financially after the loss is also very tough. If you have the right amount of insurance, then your loved ones can be taken care of financially. 

Are you confused on how to buy insurance. This could be how much to buy, where to buy and other tips to take care of 

1. How much life insurance you need?

    This is based on number of factors like your current life-style, your # of dependents and their needs & how long they need the financial help, your liabilities, whether you have income which will continue even after earners' death like Rental income or spouse working or grand-parent inheritance etc. Generally speaking, 10-15 times of your current expenses would be a good thumb rule to get the insurance for. and of course don't forget the inflation part. In 20 yrs, what you can buy for Rs 1/- will be less than what you can buy today due to inflation. 

2. Term insurance is the Best

See my other post on Term Insurance but best is not to mix investments with insurance. Usually, Term insurance is 3-4 times cheaper then Whole Life insurance so best to stick to the same. 

3. Online or Offline Insurance?

Typically, Online insurance can be cheaper given it is has less agent fees involved. However, sometimes going via agent is better for the convenience sake. Having an agent means he/she will help you during claim processing, come to the comfort of your home and be willing to answer lot of questions for you. However you pay extra for the service provided. If you are not too savvy internet user, it is ok to go via agent for extra fee which will be invisible to you.

4. Single or Regular Premium?

Some insurance companies offer two ways, one time payment for total amount due vs regular yearly payment (sometime monthly).. I suggest to go for monthly or yearly payment scheme. Reason being, it allows you to change the company later on for a better deal just in case, allows you to discontinue the payment if need be (towards end of the policy term as an example). One time payment may be little cheaper but locks you in for ever in the policy. Also, sometimes you might not have so much money to give in one shot anyways. The discount for one time payment scheme sometimes is not as much as you keeping the money in FD and paying the premium from the interest received. 

5. Lump sum or Installment payout?

 This is reverse of insurance premium. On unfortunate death, the insurance company might offer monthly payout (Installment type) or lump sum. Again, typically lump sum payment is better since monthly pay out is not as much more. Hence lump sum works out better. You would be better of putting the money in FD and instead taking just the interest portion as premium. Only time monthly could be better is if you are generally fearful or money being taken by "other" family members, friends which is non financial decision. 

6. Go for Maximum Tenure: Ensure that you take insurance till your dependents needs the money source from you. That might not just be your youngest kid completing the college , but their marriage and not to forget, for your dependent spouse's death which again you need to plan for 65 yrs+. The difference for those tenure and premium is not huge (<10% typically) so its best to buy on the little higher side for safety and mental peace. 

7. One or Split in Multiple Policies?

 Typically one insurance policy is enough since it allows to accomplish majority of the goals with good risk and safety. However, you can opt for term life insurance per goal, example, one policy for money needed for kids' education vs another for marriage and so on. and then they can be of different period saving you money accordingly by completing the policy. However, It will save you some money if you buy single policy and also less hassle to maintain and remember (Just one policy to remember vs multiple such policies). I recommend to keep it simple and have just one policy. 

8. Riders or No Riders?

 Avoid any riders opt in. Those riders cost extra and are not comprehensive. So it is best to go with default options. 

Term vs Life Insurance & Annuities

 There is a popular saying that do NOT mix investment with insurance. This is very apt when somebody is selecting insurance option. Whether to pick Term or Life Insurance. 

First up, what is an insurance. Insurance is basically a type of financial return that gives a particular amount of money to the person's family or known ones (nominee) in case of a death of the person insured. This is useful when the person has dependents, housewife, small kids or have other financial duties to cater to which the person cannot do due to untimely death. It is recommended that every investor should have insurance policy (both health and life). Now, coming to life insurance, there are generally speaking 2 options. One Term Life Insurance where, the nominee gets the money only during the coverage period and nothing else if coverage period finishes.

On the other hand, Whole Life insurance policy is such that it not only gives the money during the coverage period (Just like Term Insurance) but also gives a fixed amount of money at the end of coverage period. This "extra" money at the expiry of coverage period is the return or maturity amount the investor gets for the premium he/she paid for.

Now, the Whole Life insurance premium is obviously more than the Term life insurance with all conditions the same. this extra premium is what the insurance company "invests" and gives the maturity amount back to Investor. However, if you compute the return of this, it comes to about 6-7% a year. This return is very similar or lower than the Fixed Deposit for such a large period of time (usually insurances are for 10-30 yrs). An investor is much better off to invest via Index investing given the time frame is lot more. Or investor can take that extra money and invest in FD by himself keeping the FD deposit flexible. Whole Life Insurance sometimes also offers a facility to take loan of it but most people dont use it and again it is complicating the insurance feature with other things. 

The extra premium can be 3-4 times of the Term plan only premium. Though exact amount varies based on insurance company and return offered. But still 3-4x times is lot of money with very low return (6-7% typically)

So, all in all, it is better to buy Term Insurance policy rather than Whole Life Insurnace.

Annuities plans are similar. They promise to return a higher sum of money with long term option. But even that is not good return. The returns range from 5-7% for such a long term. Usually, Index investing, or FD is much better in these cases.

Does Bank charges interest first then principal

 Lot of times, people think that they are paying lot more interest when they take a loan and mention that one should not take loan.

As an example, if you take 50L Rs of loan at 8% for 20 yrs, your monthly EMI will be 41,822 and your total interest paid through the entire 20 yrs tenure will be Rs 50 L. So, you ended up paying 1 crore our of which 50 L was principal and little over 50L was Interest.

If you look at EMI division, out of total of Rs 41822, initial interest will be Rs 33300 while principal payment will be Rs 8500. So again, it looks like Interest payment is high.  This interest reduces to equal to principal in 12 yrs (so at that time EMI share of principal and interest will be Rs 21.5K). This share of interest will continue to reduce and in last EMI will be almost zero. 

Does it mean, one ends up paying all the interest portion upfront or early in the cycle. 

Actually, the answer is "NO". Basically, the interest is always calculated on the portion which is loan amount left. In the first month, the loan amount is full 50L so interest calculated based on 8% interest will be Rs 33300. while say after 12 months, the loan amount reduces to Rs 48.85 Lacks since small portion of principal was paid out. So in that case, the interest amount on Rs 48.85 Lacks will be Rs 32600 so it will "appear" lesser but is basically following a set path that banks are charging you interest for the amount that is outstanding (giving to you-you gave back via EMI). 

This can be further seeing from the fact that if you prepay a part of the loan, then bank gives you option to either reduce your EMI (and hence your interest amount for the money paid earlier) or reduced the loan tenure (from 20 yrs to say 15 yrs) which also reduces your interest paid. 

So, all in all, it is not that banks collect interest from you at earlier date. It is more like banks only collect interest for your outstanding balance which keeps on reducing month over month and hence interest also keeps on reducing month over month. 

Hope this helps in explanation of why interest portion is higher in fixed EMI model.