Deductions under 80C: Life Insurance

The first article under the Income Tax series was about Income Tax Slabs. Do go read it if you have difficulty calculating your taxes and the different slabs.

There are various sections under which we can claim tax deductions. And each has it’s own limits and uses. 80C is the most popular section under which people claim tax deductions. Even though I have written in brief about this section, it was in 2013 and a lot of things have changed since then.

Under this section 80C, Rs.1.5 Lakhs can be claimed for tax deductions. Money invested under this section enjoy tax deductions. They also have a long lock-in period attached to it.

There are other types of expenses that can also be claimed under 80 C and in this article I will explain in depth about what I consider to be the most important one – Life Insurance.

Life Insurance Policies are a must if you have dependents – spouse, children, parents, etc. It is double important if you have liabilities like home loan, car loan. The Insurance Policy makes sure that your dependents can maintain the same life style as they are currently enjoying even after your death.

There are lot of Insurance agents who sell policies without trying to mention the words “DEATH“. Death is the one certainty that can happen to anyone at any time. It is very important to not mince words and ensure that your dependents are well protected.

Life Insurance is needed for everyone who earns money in the family. Without their money, if you can’t lead the same lifestyle, then get that person insured.

  • If you are the primary bread winner, get insurance.
  • If your spouse also earns money, get insurance for him/her.
  • If your children are still in school or college – don’t get insurance for them.

There are many insurance providers who sell insurance policies in the name of Children Savings policy.
These are just emotional words to get your money.

When your child earns his own money, he can get himself insured. Till then, it is not needed.

The only difference is if you child earns the money in your family as an artiste and you are dependent on him/her, then you need to get them insured.

What Life Insurance Policy to buy?

Always buy a Term Insurance policy.
End of discussion.
Go on to the next section.

Ok. You are still here? Want to know why I said Term Insurance?

Lets see the dictionary definition of Insurance

Insurance
an arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a specified premium.

See how the dictionary definition doesn’t have any word called investment or savings? Term insurance is the only true life insurance policy that strictly follows the dictionary definition.

You should never mix insurance and investment. Both are completely different and should remain separate. Since term insurance is just a pure insurance product, you get more value for your money.

How much Insurance do you need?

Generally speaking you should be insured for 10x to 12x your annual income + any liabilities (loans) you have.

So if your annual income is Rs.10 lakhs and you don’t have any home loan, get a term insurance for minimum 1 crore.

If you have a home loan of Rs.50 lakhs, up your term insurance to Rs.1.5 crores.

Which Term Insurance to choose?

There are many providers to choose from and it is easy to buy a term insurance online by spending less than 30 mins. All Insurance Providers are regulated by the IRDA, so you can choose any provider. So it makes sense to choose the provider who gives the lowest price and has the highest settlement ratio.

But you should make sure that you fill in your insurance form by yourself and fill it in truthfully. The premium you pay depends on your health conditions (smoker/diabetes/heart condition/etc). If you fill it in with wrong details, there will complications when the policy is claimed. And the only time the policy is going to get claimed is when you are not alive – leading to unnecessary complications for your near and dear.

So always fill in the form properly and get the mandatory medical test to avoid complications.

Now that you have covered your dependents for cases when you might not be alive and also gotten tax deductions for the premium paid, next is to invest the remaining money for your future and also get tax deductions for that.

The next article is about my most preferred tax efficient investing method – ELSS funds. Do give me your email address below and I will send it to you as soon as I publish.

Return of Premium Term Insurance policies – worth it?

Ask any Insurance agents “Why they don’t prefer/suggest Term Insurance?”, their answer would be “There is no survival benefits”. Meaning: if you lived the entire term of the insurance, you won’t get back any of your money back. All the money you paid as premiums are for the insurance expense.

Lot of people think that argument is valid and end up paying lakhs of rupees as premium for a pathetic amount as sum assured in traditional plans. They feel that every money they pay for insurance should be returned to them.

Return of Premium Term Insurance

Some of these insurance companies have taken the hint and created a product called Return of Premium Term Insurance policies. It is just like any other term insurance policy – you pay premium every year for a higher sum assured. But at the end of the term, if you are alive, you get back all the premium you paid to the company.

I hear you saying “Thats great.” Hold your horses! For this additional feature, you end up paying higher premiums. Typically 4 to 5 time more than a normal term insurance.

For example: lets say you are 30 years old and want to take an insurance policy for Rs.1 crore. If you opt for a Return of premium plan you might have to pay approximately Rs.32,500. At the end of 30 years if you are alive, the company would pay you back Rs.9.75 lakhs – the entire premium you paid. On the other hand, a plain Term insurance would cost you about Rs.7500 if taken online.

You may say, but this extra Rs.25,000 is not that bad right? One can get the best of both worlds. High sum assured for life coverage and also get back all the money they put in (even if they are willing to lose the interest for 30 years).

Lets see if we can beat this Rs.9.75 lakhs payback by taking just a plain term insurance and investing the remaining money somewhere else. Even if there is one safe investment that can beat this returns, this insurance product is a waste of your money. Our objective here is to invest Rs.25000 per year in some investment product and hope to get back more than Rs.9,75,000 at the end of year 30.

Public Provident Fund

Public Provident Funds or PPFs are the most safest way to invest and get tax benefits + tax-free returns. I have already talking about PPF earlier. The lock-in period of 15 years isn’t important as we are going in for the really long-term of 30 years. Lets see how much we will get after 30 years at the rate of 8.7% (current rate of interest).

In 30 years, by investing Rs.25,000 every year in a PPF account and extending the account till 30 years, a person would end up with Rs. 35,03,013. Rs. 35 lakhs. Compared to the Rs.9.75 lakhs this is so much more and also PPF accounts are backed by the Government of India, unlike your insurance company.

Equity Mutual Funds

Equity Mutual Funds are optimum for people who want to take a little bit more risk as it helps you earn better returns than any other asset class. Also invested for over 30 years, equity markets are the best investments which can provide inflation beating returns.

But lets not be too greedy for higher returns. Let us assume a very moderate and easily achievable 12% return. Note that I am not claiming 16% returns which is what Sensex has given over the really long period.

The important part to note here is we will be spreading our investments over 12 months x 30 years – in the form of a Systematic Investment Plan (SIP) to average out any volatility in the market.

Can you guess how much you will have at the end of 30 years by doing a SIP of Rs.2083.33 per month, earning a return of just 12%? Believe it or not, it is Rs.73,53,975. Rs. 73 freakin-lakhs is more than 7.5 times higher than your amazingly new “Return of Premium Term Insurance” policy that the company is trying to sell you. If you assume the usual long-term rate of return of 16%, you would get Rs.1.85 Crores.

Which route are you going to take?

I have laid out the numbers in front of you. You can check them out with the numerous calculators you have on the web. The options you have are very simple:

  1. Return of Premium Term Insurance at Rs.32500 per year and lose most of your premium to inflation? Rs.9.75 lakhs
  2. Plain Term Insurance (Rs.7500) + PPF (Rs.25000) and get back Rs. 35 lakhs
  3. Plain Term Insurance (Rs.7500) + Equity Mutual Funds and easily get back more than Rs.73 lakhs.

Comparison of Term Insurance + Investments

 

Next time some insurance agent comes to you and suggests you buy some revolutionary new product which will give you amazing returns, sit back and take out your calculator. Ask them to show how much returns their product gives and compare it to the returns an Equity Fund or the plain old trusty PPF gives. Let them beat PPF’s returns first, then we can think whether or not its revolutionary.

Always remember, life insurance is an expense and not an investment. If all things go well, you or your dependants shouldn’t ever get a cheque from your Insurance Company.

This analysis and results are very similar to the ULIP vs PPF vs Mutual Fund analysis I made earlier. You might also want to check that out too.

Who does NOT require a Life Insurance?

There are two extremes when it comes to buying Life Insurance and there are quite a bit of people who are at both these ends. I know intelligent people who are at both these ends and it isn’t surprising I see a lot of such examples online in various forums. The two types of people are:

  1. Who think Life Insurance is the only safest form of investment in the whole wide world.
  2. Who think Life Insurance is needed only to claim the 80C tax benefits.

Insurance is the Best-est investment

The first category is brain-washed by the old LIC agents who get big, fat agent commissions whenever you pay your premiums. Their agents only sell them traditional policies, because the premium is higher and the agent gets more commissions. These people need to read more on how traditional insurance policies are one of the worst performing investments (I wouldn’t even call it an investment). But this post isn’t for them.

Life Insurance? I don't need Life Insurance.

Insurance? I don’t need no Insurance

This post is for the people on the other extreme – those who think that Life Insurance is just a way to get tax benefits under the section 80C of Income Tax. They don’t understand the meaning of the two words “Life Insurance”.

I have a friend who on getting his job, immediately took a home loan and bought an apartment. When I asked him how much insurance he has taken, he said “Insurance? why would I need that? I already claim all my 80C from the PF and housing loan principal. I don’t need to invest anymore for 80C.” He thinks insurance under 80C is a way for the government to get more money from tax payers.

He has a pretty heavy liability in the form of a home loan and both his parents are dependant on him. When I asked what would happen incase he dies, he says that his sister would repay the loan or his parents would sell the apartment and live off the interest from that money.

What a dumb answer. His sister already has a home loan of her own and she has a family with kid for whom she needs to provide education. And his other idea of selling his house and living off that money? When they sell that house, most of the money will be used to repay the bank and they would get back a very small amount (maybe a few lakhs) and that money isn’t enough to earn interest for two people to live off, especially with the rising costs.

Do you need Life Insurance or not?

To know if you need Life Insurance or not, let me ask you a few set of questions here.

  • Do you have parents who are dependant on your income?
  • Are you married and you have a spouse who is dependant on your income?
  • Or are you planning to ever get married in your life?
  • Do you have kids? Or are you planning to have kids?
  • Do you have any kind of liability – home loans, car loans, personal loans? And if you die does your dependants be burdened to repay these?
  • Do you have any one else in your immediate family dependant on you for their living? like siblings?

If the answer to even one of the question is a “Yes”, then “Yes, you need life insurance”. If I need to slap you to get that into your brain, I don’t mind doing the honours.

If you answered “No” to every question, then you can skip your life insurance.
In other words, if you are going to be Forever Alone, then you don’t need life insurance.
If you die and no one’s financial life is going to be affected, then you can skip it.
If not even a single person is financially dependant on you, then you don’t need life insurance.

Number of people falling under the “No to all” category, especially young, salaried people or people with their own businesses will be less than 1%. And there is a high probability that you don’t fall under that category. So go ahead buy a online term insurance and make sure your dependants are not left in the dark when you are not there to support them.

Best time to buy a Term Insurance

If you don’t have an adequate life cover, then the best time to buy a Term Insurance is Today and Now. Just go online and buy one. Don’t wait.

Birthday Cake
Birthday Cake

But if you want to be a bit smart about it, you can time the insurance buying & premium payment, so that you can pay lesser premium. The trick is to buy your term insurance before your birthday. But make sure you have enough time for the form filling, document submission, re-submission (yeah it happens), medical test, etc. I would suggest a month before your birthday would be ideal.

Term insurance premiums are calculated by your age and with each increase in the year, the premium cost goes up. So by taking a term insurance well before the birthday (instead of just after one) you are locking the premium for the entire term (30-35 years).

Also remember to time it on a month where you would have enough cash at hand. For example, March is a bad time to take term insurance. With all the last-minute taxes to be settled it is too much of a hassle, especially if you are salaried and this extra Rs.10000-12000 will make or break your month.

I would suggest to make all your tax savings or annual payments before the end of December and have the entire January-March period free. Saves you a lot of sleepless nights.

Also make sure you don’t have it during the April-June period as you might have to pay your kid’s education fees (even though “kids” might be in the future).

One can easily plan for such repeated expenses properly and don’t have to worry about borrowing money from banks/friends.

So if your birthday is coming up in the next few months, go ahead and buy that term insurance now. If your birthday was just over and you still don’t have term insurance, well, go ahead and buy that term insurance now.

ULIP? Pfft, get better returns & insurance cover on your own

Lot of people get misguided into buying Unit Linked Insurance Policy (ULIPs) by insurance agents. I happened to read the application form of a person who recently applied for HDFC SL ProGrowth Flexi Plan. Reading that, I wondered if I could come up with a better plan than this ULIP plan – with better returns and better insurance cover.

First let me give a brief introduction about the person. He is a 41-year-old male living a few streets down from my home. He has his own fruits shop in the Koyembedu Wholesale Market Complex (the largest in Asia). He is a healthy person, married and has a 7-year-old kid. His income is about Rs. 800,000 per year everything from his business.

Unit Linked Insurance Policy

His policy is for 10 years with a cover of Rs. 600,000 with his kid as the nominee. For this he pays a monthly premium of Rs. 5000 (Rs. 60000 per year). End of 10 years he would have paid Rs. 600,000 as his premium with a life coverage of just Rs. 600,000.

Since this is a unit linked policy, if the market performs better, his fund value and his investment also increases. But by how much? The insurance companies need to show a projected statement of premium, fund value, death benefits, etc., for 4% and 8% returns. If he dies anytime when his policy is valid, his son would minimum Rs.600,000. No problem with that.

Lets look for the most likely scenario – he lives through the term of the insurance and after 10 years gets back his investment. At 4% return he would get back Rs. 623,135 and at 8% rate he would get back Rs. 764,405 after 10 years. Lets take the higher 8% as our calculation from here on. So he earns Rs. 164,405 extra from an investment of Rs. 600,000 over 10 years. But that looks a bit low isn’t it? Can we do better?

I am assuming he wants to invest the same money (Rs. 600,000) for about same number of years (at least 10 years) and get same insurance cover (minimum Rs. 600,000). There are two parts to this investment. Part of the money needs to be for insuring his family/son against his sudden death. The remaining money can be invested in some other instrument. Remember, he might have applied for this ULIP to get tax benefit under the section 80C. So our proposed investment should also get benefits under 80C.

Insurance

First, he should take a term insurance to protect his family in case of his death. Using HDFC Life’s Click2Protect calculator, for an insurance policy cover of Rs. 10,00,000 (the minimum available) and 10 years, he has to pay a premium of just Rs. 2980/year. Lets round it up to Rs. 3000 for easy calculation.

Term Insurance Premium Calculation
Term Insurance Premium Calculation

This is the amount he needs to pay for just insurance and he gets extra cover of Rs. 400,000 than the ULIP. I would suggest he go for at least 15-20 years as his son would’ve just joined college (at age 17) when the policy term completes. If he dies at year 11 (age 52), his family would have no income as the kid hasn’t yet started earning. Increasing the term to 20 years would just increase the premium by extra Rs. 900 only (Rs. 3880).

But just for the  sake of comparison with the ULIP let’s go with the 10 years policy of Rs. 10,00,000.
Premium paid: Rs. 3000/year.
Remaining money to invest: Rs. 57000/year.

Investment

There are many forms of investment under 80C, like PPF, Home loan principal repayment, National Savings Certificate, ELSS mutual fund, etc. Let me just take two of such investments. One is the most safest and the other will be investing in equities (just like the ULIP scheme). Lets see how they compare against ULIP.

Public Provident Fund (PPF)

This is the most safest and best investment if you want assured returns. An individual can invest a maximum of Rs. 100,000 per year in it. He needs to be invested for minimum 15 years. However the minimum deposit needed to keep the account active is just Rs. 500. So lets assume he invests all Rs. 57,000 in PPF for 10 years and from year 11-15 he deposits just Rs. 500 to keep the account active. He can make monthly deposits of Rs. 4750 and his PPF account keeps accumulating all the money.

How much do you think the money grows to, if he puts in Rs. 57,000 per year till 10 years at the current rate of 8.7%? At the end of 10 years he would have Rs. 927,966 and if he just keeps putting in the minimum deposit for 5 more years, at the end of year 15 he would have a cool Rs. 1,411,484. What? 14 lakhs? That is more than double his investment, in fact Rs. 811,484 more than the Rs. 572,500 he puts in.

PPF Returns PPF Returns graph

ELSS Mutual Fund

ELSS or Equity Linked Savings Scheme puts your money in the stock market and the government gives 80C benefits for money put in this scheme. Lots of mutual funds have ELSS schemes and while not everyone is good, there are some better performing schemes also. It is locked in for 3 years and since long-term capital gains in Equities aren’t taxable, any money he takes out after the lock-in period is totally tax-free.

I know it is not fair to do an investment just based on previous fund performance, but we can’t predict the markets to do a future performance calculation too. So let me take a fund which has been in existence for at least 10 years and lets see how much a monthly investment of Rs. 4750 would’ve grown. I chose ICICI Prudential Tax plan and the investment was from April 1, 2004 to March 1, 2014. We stayed on this scheme throughout the bull and bear markets. This is just for a comparison and the performance might not be sustainable in the future and this isn’t a recommendation for this fund/scheme.

ICICI Tax Plan SIP Returns

See how much it would’ve grown in 10 years? Rs. 1,208,195. Rs. 12 lakhs in 10 years. Which is significantly more than what he would’ve got in PPF (remember it was just Rs. 9.27 lakh in 10 years). Even more interesting is, how it is phenomenally more than what he would’ve got if invested in the ULIP’s feeble 8% rate. Plus ELSS has the lowest lock-in period of just 3 years among all 80C investments. 

Even assuming that ULIP gives better than the 8% rate, lot of the initial money he invested goes into managing the fund, agent’s fees, etc. But direct investment into ELSS means no such losses and all his money is invested under his name. So it’s returns will be definitely less than you investing directly in other mutual funds.

How does all three options stack up?

At the end of year 10, his investment in the three options will have grown to Rs. 7,64,405 in ULIP vs Rs. 9,27,966 in PPF vs Rs. 12,08,195 in ELSS Mutual Fund (based on past performance). Even if we add 1 or 2 lakhs to ULIP because the markets might have performed well, it would be definitely lower than investing on your own.

ULIP vs PPF vs ELSS
Year ULIP PPF ELSS*
1 55195 61959 81487
2 114011 129308 231046
3 178432 202517 273011
4 247092 282095 356335
5 320285 368597 265687
6 397984 462623 678394
7 480893 564831 809133
8 569413 675930 838142
9 663886 796695 952014
10 764405 927966 1208195

ULIP vs PPF vs ELSS

What if he dies before 10 years?

Now lets see what happens if he dies before the term completes – for example, on the last month of his 10th year into the policy/investment.

ULIP

From seeing the official illustration of the ULIP application, I see that on death the nominee gets back just the insured amount, in this case Rs. 600,000. If he happens to die on year 9 the payout is Rs. 663,886 and on year 10 is Rs. 764,405 if the fund performs at 8%. His family doesn’t get anything more than that.

Term Insurance + PPF

If he had invested as suggested above, his insurance is separated from his investment. So on death his insurance company will pay Rs. 10 lakh (remember how Rs 10 lakh was the minimum in term insurance). But his PPF account is separate and all his investments will also be available for the nominee immediately upon his death.

So if he dies on year 1, the amount received is Rs. 10 lakh + Rs. 61959 and on year 10 his son will get Rs 10 lakh + Rs. 927,966. Double Benefit. That is the advantage of keeping your investment and insurance separate.

Term Insurance + ELSS

The logic behind this is similar to Term Insurance + PPF. Only catch is instead of immediately getting the invested money, the nominee has to wait for a 1 year lock-in to complete since the buying of the original units by his father. His kid will get both Rs. 10 lakh from the insurance company and the money he invested in the mutual fund. He could let it grow in the same scheme or switch to a different scheme if needed.

How difficult to set this up?

Actually it isn’t that different from starting a ULIP. You can use the help of an agent or even do most of this online. Both your term insurance and PPF/ELSS can be setup to take money from your savings account automatically. Insurance payment is done once a year, so that is quite easy. PPF/ELSS has the advantage of investing either monthly as SIP or investing in lump sum each year.

Investing monthly is better as one doesn’t have to worry about cash crunch in a particular month. Rs. 4750 every month for some one who earns more than Rs. 60,000 every month isn’t a very high amount. Also SIP gives the benefit of Rupee Cost Averaging to get more units when the market is at the lows.

Verdict

Instead of accepting what an insurance agent (should we say “insurance seller”) says, it’s better to think on our own and see if we can get better returns. Remember “Do Not mix Insurance and Investment.” Next time someone tries to sell you an insurance policy, ask them how they can give better returns & coverage than your own term insurance + investment plan.

Ask them to give in writing that their plan is safer than term insurance + PPF or gives better returns than term insurance + ELSS. I am sure no insurance agent will be able to do it.

TL;DR

If you want safe returns: Buy a term insurance and invest the remaining money in PPF.
If you are willing to take some risks: Buy a term insurance and invest the remaining money in ELSS Mutual Fund.
If you want the best of both world: Buy a term insurance and invest half the money in PPF and remaining half in ELSS mutual fund.