Things to know before buying a term plan

Imagine a world where you could potentially buy a product that could replace you. Okay, not you precisely, because that would be a bit silly. But what if you had a replica version of yourself that could earn like you and make money like you. Wouldn’t you jump on that opportunity? Or maybe pay an annual fee just so you could hold on to this person? You probably would. And a term insurance product does just that. It is your financial replica and it comes alive when you die.

Let me explain. When you buy a term insurance product, you pay a small fee every year to protect your downside. And in the event of your passing, the insurance company pays out a large sum of money to your family or your loved ones. Think — 1 Crore or 5 Crore or even 10 Crore. Ideally, this money should replace you financially. It should support your family when you’re no longer the breadwinner. And unless you’ve deliberately misled your insurer whilst buying the policy, they will pay out the full amount the moment you die. Hell, even if you do mislead them, they have 3 years to uncover the fraud. If they don’t do it by then, they are mandated to pay out, no questions asked. So unless you commit suicide within one year of buying the policy or you died while committing a crime, your loved ones will get this money.

And while the base product is simple enough to understand, some key questions still remain and we will address that in the next section.

The first question should be obvious by now — How much money do you need to replace yourself financially?

It’s a tough question and let’s be honest — It is a bit subjective as well. But there are a few key things you have to remember here. For starters, your expenses. If your lifestyle demands a certain level of spending you will need to keep it up if you don’t want your absence to be felt. So if you’re spending 50,000 every month, your term insurance product should replace this income. And at that rate, you’re probably looking at a cover totalling 1 Crore. Let me explain why.

Think about what your family would do if they received this money. Assume they do the least sophisticated thing possible — which is probably the smartest thing to do as well.

At 6% annually, they will receive 6 lakhs each year. That should adequately compensate for your lost income. However with inflation, that 6 lakhs might start looking paltry very soon. So let’s try and beat inflation. Let’s assume the insurer pays you 2 Crores. That should get your family 12 lakhs each year. A pretty good sum overall and maybe good enough for the next 10 years. But what if you have a lot of financial obligations? Loans and that sort of stuff.

Then you should start looking at a higher cover. And while these are rough estimates, I hope you get where I am going with this. The final amount should generate enough cash flows for a reasonable amount of time to pay for all your family expenses (including EMIs) and also leave a little extra for your family. We will soon have a calculator up on Ditto. So keep an eye out for that.

Remember. With a term insurance product, you keep paying your premiums until you die. Or the policy lapses. So there is an expiration date of sorts and it’s on you to decide how long you want to keep your policy. And you have to make this choice at the time of purchase. You can’t change it afterwards. So there’s a lot riding on this.

Once again, you are looking to replace yourself financially. But you are only doing it because — When you’re young, your family won’t have a lot of savings to fall back on. As you grow older, however, that changes. For instance, by 60, your kids will be all grown up. Your spouse will likely have a retirement fund to lean on and you won’t have many dependents to worry about.

So 60 could be a good place to start. But the insurance company knows something. The average life expectancy in India is about 70. So if you are intending to keep the policy beyond 70, know that your premiums will shoot up. Like a lot. And that means the sweet spot is somewhere between 60 and 70. Any number in that range should ideally serve you well.

And while this overview should help you understand term insurance, there are a few add-ons aka riders you can attach alongside the base policy to make sure your financial replacement is as robust as you. And the most useful rider of them all is a life stage benefit.

Imagine one day, the doctors tell you that you will be confined to a wheelchair permanently. It’ll be devastating, I know. You will have to quit your job. You will have to figure out a way to make a living despite your condition and in the meantime, you will have to relook at your investments, prune your spending and maybe even drop your term insurance policy.

How are you going to pay 15,000 every year in premiums, eh?

That money could come in handy elsewhere. But what if it didn’t have to be this way? What if the insurer allowed you to keep the policy even without paying your premium.

See… Your condition is unique. You would have persisted with the policy if you hadn’t been disabled. So some insurers will allow you to opt for a waiver. That’s them telling you — Pay a small fee and you won’t have to worry about your premiums in the event you are disabled. You can still keep your policy!!!

And while the waiver I just described kicks in if you are permanently disabled, you could also opt for a waiver if you are diagnosed with a critical illness — like Cancer.

A waiver of premiums might not sound like much. But if you are permanently disabled or if you are forced to quit your job because of a critical illness, this benefit could be a lifesaver. So maybe you should actively consider both riders.

We have lax enforcement of traffic laws. We have terrible roads and poor street lights. We have reckless drivers and speeding motorists. And as a result, there’s a fatal accident in this country every 4 minutes.

And if you’re worried about this statistic maybe it makes sense to opt for an accidental cover. In which case, the insurer pays out an additional 1 Crore to the family on top of the term cover (2 Cr.) if you died in an accident. And while these numbers are for illustrative purposes only, you can see how it can add an extra layer of security for your dependents, no?

If you pay a little bit extra alongside your base premium, your family could get some extra money and some extra protection in the event you die from an accident. But having said that, you must never reduce your term cover just because you have some protection here. That is a bad idea.

Critical illnesses like cancer are hard to deal with. Granted, your medical bills will be taken care of if you have an extremely comprehensive health insurance policy. But once diagnosed with a debilitating disease, you’ll be forced to take a break. You won’t be able to go to work. And your family will have to make do without your income.

But if you opt for a critical illness benefit, things won’t have to be this grim. In the event, you are diagnosed with a critical illness, the insurer will pay out a portion of your term cover in cash to help you tide this crisis. It could be 10 lakhs. It could be 50 lakhs. It could be 1 Crore. All you have to do is choose the amount when opting for the benefit and you can use this money to replace your lost income if you are ever diagnosed with a critical illness.

A critical illness rider will make your life so much easier. But remember — most policies will pay out the corpus from your sum insured. And your term cover will reduce by an equal amount.

Term Insurance is weird. You pick a number — your total cover. The insurer promises to provide the said cover in case you die. And in return, you continue paying a premium every single year until that day comes. Or your paying term concludes. And while there is nothing peculiar about this arrangement in itself, think about the implications of your decision 15 years from now. A one crore cover might look paltry if you haven’t taken inflation into account.

Which is why most people decide on the sum insured assuming inflation will continue to make ground each year.

But what if you didn’t have to worry about all this while picking a cover. What if your sum insured grew by 5% or 10% each year? That would save you a whole lot of trouble. However, premiums for these plans are going to be much higher than your usual straight forward term insurance. After all, there is no free lunch in this world. So if you are looking to buy a term policy with an increasing cover each year, remember your premiums are 50 to 60 % higher as well. So it does make sense to take into account for inflation beforehand which we do help out with.

You could opt for this benefit or you could simply do the calculation right now and pick a larger cover that will protect against inflation. It’s on you really.

Remember how I introduced term insurance as a product to replace you financially? Yeah, we need to revisit that. See, as you grow older, your dependents may no longer be as dependent on you as they once were. Your kids grow up. Your savings corpus increase in value. You will have enough money to cushion against any headwind. More importantly, your financial obligations will no longer look insurmountable.

Think about it. If you’re a young lady with a home loan, you have to worry about paying your EMI each month. And in the off chance, you pass away, the burden shifts — to your spouse or even worse, your kids. So obviously you need better protection. You need a higher cover. But once you are through with the EMIs and your kids start working, maybe you won’t need the same level of protection. Maybe replacing you financially won’t be that big of a challenge. So some insurance companies offer you the option of decreasing your cover as you grow older. And that obviously means you will have also have to pay lower premiums as your cover diminishes in value.

While this might be a feature some people would seek, it’s very hard to predict future financial obligations. So if you are opting for this rider, make sure you are doubly sure you won’t need a massive cover as you grow older.