You have bought a term cover of Rs 1 crore. As per your calculation, the amount should be enough for your dependent family to maintain their lifestyle and achieve all important life goals (education, accommodation, healthcare, marriage etc). Let’s assume Rs 1 crore is enough.
If something were to happen to you, your family will get a lump sum amount of Rs 1 crore. However, the expenses of your family won’t be lump sum. They will need to some amount every month to meet monthly expenses. An aspect that worries me is how to use this lump sum amount to generate regular income.
I was talking about my term cover with my wife a few days back. Of course, she was reluctant to talk about this. But when I insisted, she relented. After listening to me patiently, she asked me a question, “What should I do with this money? How should I invest this money?” I realized leaving behind a good amount is not enough, the dependents must also know how to use that lump sum.
Must read: Pass your financial knowledge too, not just financial investments
Have you asked yourself the same question?
Can your family manage to generate regular income from this lump sum amount?
Certainly not easy for someone who has no prior experience of investing and selecting financial products based on requirements.
Moreover, once the money reaches your spouse’s bank account, tens of agents of financial products (primarily insurance companies) will start preying on that money. Most of them will be the least bit worried about financial and emotional stress your family must be going through. They will be more worried about their commissions.
Even distant relatives (with every bit of good intention) will start offering financial advice. Everybody is an expert advisor.
For someone who has never made investment decisions before, it is not easy to handle so much noise. That too in times of such emotional stress.
Is there a way by which your family can be spared this stress?
Must read: How much Life Insurance do you need?
Variants of Term plans
Term plan is the best form of life insurance. And it remains so. However, a term plan can also come in multiple variants.
Just like regular term plans, there will be no maturity benefits in any variant.
The nominee gets the Sum Assured only in the case of demise of the policy holder.
The difference is in the way the Sum Assured is paid to the nominee or beneficiary under the policy.
In regular term plans, the entire Sum Assured is paid to the nominee in the event of death of the policy holder.
Under other variants, this may not be the case. The payout may be staggered. Some examples are:
- Fixed monthly payout for a certain number of year (say 120 months) e.g. Rs 1 crore of Sum Assured will be paid as monthly installment of Rs 1 lac for 100 months.
- Part amount as lump sum and remaining as monthly payouts for a fixed number of months. Rs 50 lacs lump sum and Rs 50,000 per month for 100 months.
- Monthly payouts which increase at a certain rate (rate of inflation or a fixed percentage) every year for a fixed number of years.
There can be any number of variants. Insurance is a contract and a contract can be put down in any way.
Let’s call these variants of term plans Income Replacement Term Insurance Plans (to differentiate from regular term plans). There is no standard nomenclature. I researched a few plans but could not find a consistent name. Income Benefit Plan and Income Replacement Term plans were most commonly used.
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What are the benefits of Income Replacement Term Insurance Plans?
Generating income from a corpus is not the easiest job in the world. Additionally, our brains are not programmed in such manner. Your family has a monthly income and the family tries to adjust expenses within that income. Your spouse (family) has been doing this for many years. And it is difficult to get rid of these old habits.
An Income Replacement Term Plan will ensure that your family stays within that comfort zone for another 10-20 years. In the meantime, your family can develop an alternate source of income or learn to generate income from the assets you left behind.
The premium for income replacement plans is comparable to regular term plans. Hence, such plans are not expensive either.
We will see this through an illustration later in this post.
What are the problems with Income Replacement Term Insurance Plans?
Regular term plans are the easiest to understand. If the policy holder dies, the beneficiary gets the Sum Assured.
These plans may not be as easy to understand.
With Income Replacement Term Insurance plans, the payout is staggered over multiple years. Hence, it may not be as easy to understand these plans.
- Unlike regular term insurance plans, comparing these plans is not easy.
- You need to discount the cash flows from the Income Replacement Term Plan if you want to compare two such plans. The choice of a discount rate is a problem in itself. You can use expected inflation as the discount rate.
- Fancy names for such income replacement term plans can confuse you.
- Since the product can be structured in so many ways, the product itself may not be so easy to understand. Hence, you may end up purchasing a product that you don’t fully understand.
Illustration
HDFC Click 2 Protect Plus plan (from HDFC) is a term life insurance plan and comes in three variants.
- Life option: Lump Sum payout of death benefit
- Income Option: 10% of Sum Assured payable on death. Remaining 90% shall be paid be monthly income for as monthly income for the next 15 years (0.5% of Sum Assured every month)
- Income Plus Option: 100% of Sum Assured to be paid on death. Monthly income (0.5% of Sum Assured) paid for the next 10 years. The monthly income can be chosen as level or increasing at 10% p.a.
You can see first variant is a regular term plan while the remaining options are Income Replacement Term Insurance plans
Please understand income replacement term insurance plans can be structured in any way. So, you can have a plan where there is no lump sum payment at all and the entire Sum Assured is paid in monthly installments. 10% could be 35% or 50%. (under income option). This is something you need to watch out for.
Let’s compare the premium for the three variants for Sum Assured of Rs 1 crore for a 30 year old non-smoker male. Policy term is 30 years.
You can see, in the first two options (life and income), total payout is same. However, in the income option, most of the payout is staggered over 15 years. Hence, the present value is only ~Rs 62.3 lacs.
That is why annual premium for Life Option is greater than annual premium for Income Option.
The payout form the Insurance company is higher in Income Plus options. That’s why the premium for Income Plus option is also higher.
Please understand this plan from HDFC Life has been considered only for demonstration purposes and shall in no way be construed as my recommendation for the life insurance product.
PersonalFinancePlan Take
When you calculate life insurance requirement, the underlying assumption is that the beneficiary knows how to use the money. If your spouse (or family) has no idea about how to invest the lump sum amount, your family may face serious financial problems after a few years.
When it comes to life insurance, you must take decisions that are easy to understand and implement for your family. It is acceptable even if the choice is a bit sub-optimal.
If you think spouse (family) may find it difficult to handle the lump sum amount efficiently, you can consider Income Replacement Term Insurance Plans.
Income Replacement Term Insurance Plans make a lot of sense if yours is a single earning household and your spouse (family) is not financially savvy or comfortable with making investment decisions.
What should you do?
- Involve your spouse (family) in all the financial decisions. If you are opening an FD, tell them why you are opening a fixed deposit (and not purchasing a traditional insurance plan with tax benefits). Experience is the greatest teacher.
- For someone who has not taken courses in mathematics or finance or is not financially savvy, it may not be so easy to understand investment return concepts such as CAGR or the cost of a financial product. It is your duty to educate your family.
- Encourage them to read personal finance sections in daily newspapers or visit certain personal finance blogs regularly. Slowly but surely, their understanding of financial products will improve. I understand it is easier said than done. But, slow and steady wins the race.
- Discuss (or rather debate) with your spouse how you want insurance proceeds to be used. I know such subjects are never broached in our families but such discomfort is much better than the prospect of financial hardship for your family. You can even put the plan down in writing. Your family can refer to the same if the most unfortunate were to happen.
What you should do about your insurance needs?
- Calculate your life insurance requirement and purchase a regular term plan for the same. Lump sum amount may be necessary to square off certain liabilities e.g. home loan etc.
- If you are confident that your spouse (or family) will be able to manage the lump sum amount to generate regular income, then there is no need to purchase another insurance plan.
- Alternatively, if you have created assets which can provide regular income to your family, you only need a regular term plan (and not a variant). For instance, if you have a second home which provides rent good enough to meet family’s monthly expenses, you do not need income replacement term insurance plan.
- If you feel your spouse (family) is not financially savvy, you can add an income replacement term insurance plan to your portfolio. The monthly payout from the insurance plan shall be in line with your monthly take home salary (or at least monthly expenses).
- If the premium for the two plans is too much for you, you can reduce the life cover under regular term plan. However, I would rather be over-insured than under-insured.
- You can also purchase a term plan that provides both lump sum and income benefits.
To be honest, there is no crisp answer to whether you need an Income Replacement Term Insurance Plan. It depends on your specific situation. So, you are the best judge.
You can seek services of a SEBI Registered Investment Advisor or a fee-only financial planner to help structure your insurance portfolio. Such advisors will help you work out the exact numbers.
Regular term plan is necessary since the payout from Income Replacement Term Plans stops after a few years. Income Replacement term insurance plans are not life annuity products i.e. these plans do not provide monthly income for lifetime. The monthly payout will stop after a few years (10, 15, 20 or as the case may be). Before the monthly payouts stop, your spouse (family) must learn to generate income from the assets you left behind or create other alternate source of income. Awareness about financial products is an absolute must.
Image Credit: DLG Images, 2015. Modified. The original image and information about usage rights can be downloaded from Flickr/DirectLine
27 thoughts on “Income Replacement Term Insurance Plans: You may need one”
Aptly captured! It’s a must to have an income replacement plan offering payment equal to ~1.5 times the monthly expenses. This will ensure that the payout will be enough even if the unfortunate event takes place within the next 5-7 years.
Thanks Lucky!!! Glad you liked the post.
Very good article!
Thanks Dhruman.
Please do share with friends and family.
Since I have already made a regular term insurance, could you suggest where my family should invest the lump sum amount to get good monthly income?
Would this option be financially more or less profitable than an income replacement term insurance plan?
Thank you.
I assume you want to know where your family should invest if you were not around.
Difficult to comment, sir. They are many ways. They can invest in FD with monthly payout. They can also purchase annuity plans. There is POMIS, SCSS (for senior citizens) etc. If you own a second house, rental income can provide monthly income.
Yields on annuity plans are quite low. Rental yields are also quite low.
They can also have a customized investment strategy. They can have a mix of debt (short term) and equity (long term).
However, they might require guidance to implement such strategy.
A lot depends on how much corpus you leave them with and how much they need every month.
Term insurance is not an investment, so it is not comparable to any investment. A life insurance plans covers the risk of an untimely demise.
Dear Deepesh
Very nice detailed Explanation
I am an NRI i would like to take term insurance with regular income option please suggest term plan that is suitable to NRI
Thanks Rohit!!!
Glad you liked the post.
Not much to differentiate between Term insurance plans. Pick anyone. Go with the insurer or the band you are more comfortable with.
Almost all companies offer term plans with regular income.
Since you asked, you can consider plans from ICICI Prudential or Max Life.
Btw, you can also consider purchasing term insurance in your country of residence too (rather than buying in India).
Thanks dear for quick answer
I would like to know is there any NRI clause to be check before buying any term plan
I don’t think so. However, do read terms and conditions and get clarity about the claims process from the insurance company before you purchase. This is important if the demise of the policyholder were to happen abroad.
Hi Deepesh,
I am 33 years old, non-smoker and don’t have any illness history.
My Insurance detail as per following
1. LIC Bima Gold, Premium INR 23748, sum assured INR 5 Lakhs, Term 16 Year, Purchased in 2006
2. ICICI – Guaranteed Savings Insurance Plan, Premium INR 60000, Sum assured INR 4.2 Lakh, Premium term 7 Year, Policy Term 15 Year, Purchased in 2012
3. LIC Jeevan Saral (With Profit), Premium INR 40000, sum assured INR 8.5 Lakhs, Term 15 Year, Purchased in 2013
4. Max Life – Online Term Plan, Premium INR 7000, sum assured INR 50 Lakhs, Term 35 Year, Purchased in 2014
Please suggest on the following:
1. Special Advice required for ICICI – Guaranteed Savings Insurance Plan – Shall I surrender it or stop the premium and keep the plan. As per ICICI Estimated Surrender value as on 6/2/2016 policy is Rs. 82,393.19/-
2. Should I surrender LIC Jeevan Saral/ Bima Gold plan? OR just I stop the premium and keep the plan.
Thanks
Hi Rohit,
I wouldn’t go into specifics of every plan. I am offering only generic advice.
Go through the following post for more on this topic.
http://www.personalfinanceplan.in/insurance/life-insurance-continue-or-surrender-or-paid-up/
The decision is never so simple.
These plans (except Max Life plan) were bad choices in the first place.
1. As I understand, you have already paid 5 premium out 7 for ICICI Plan. Do not surrender the plan. Pay the remaining two installments and be done with it. You can also make the plan paid up.
2. Jeevan Saral: Make the plan paid up. Bima Gold: You can continue till maturity or make the plan paid up.
Thank you Deepesh for your valuable reply
Sir
At present which pension fund manager to be choosed and life cycle fund for 2 boys aged 28 and 32 respectively.
Which auto choice option is good. Or active choice.
Per month can invest 1500 each.
You talking about NPS?
Sir
At present which pension fund manager to be choosed and life cycle fund for 2 boys aged 28 and 32 respectively.
Which auto choice option is good. Or active choice.
Per month can invest 1500 each.
Thank you sir
Hi Deepesh,
Very good explanation and detailed writing.
I have one query. Can we take term insurance online without any agent help?
I am planning to take Tata aia life insurance iraksha trop, which is an online policy. Sum assured as 1 Crore and premium payment term for 5 years.
Is it advisable to take this one. I am worrying that there might be any issues while claiming the amount on unfortunate event.
Hi John,
I get your point. Good agents can help but I doubt insurance company will reject a claim just because the agent was not involved.
Or an agent can get a claim passed if the insurance company has rejected.
For all you know, the agent may not even be around when the time for claim comes. The family will have to run around in that case.
If you feel your family can file claim on own, you should go for online plan.
or else you can consider going through an agent.
If you go through the agent, ensure that the correct information is passed to the insurer.
I have heard cases where agents have hidden information just to get the policy issued. You
Thanks for your reply.
Can you suggest one to go from the below two policies or any other product with similar benefits,
1.Tata AIA life insurance Sampoorna Raksha Plus
2.Tata AIA life insurance iraksha trop
Age 27, Policy term 30 yrs, Premium pay term 10 years, Sum Assured 1 Cr
Hi John,
Can’t comment on specific products.
Purchase a pure term plan. Do not go for return of premium plans.
Suggest you through the following post.
https://www.personalfinanceplan.in/insurance/does-it-make-sense-to-purchase-a-term-plan-with-return-of-premium/
We can opt Lumpsum+Income Option because,
The income option provides the income for 10/15/20 years based on the selection and it is totally Tax free. You can completely enjoy the benefit year on year.
Whereas the Lumpsum you get, the first year it will not be accounted for income tax. when you invest in long term deposit will be accounted for tax from the second year.
So the combination is better use of the amount by the family when they don’t have knowledge to earn other than monthly income. from fixed deposits in any Banks.
You have raised a good point.
However, it is not about return or tax.
The choice must depend on the family’s comfort in handling money.
Very Good article. Thanks for the same. Can you clarify if the income option is selected is that income tax free??
Yes, even the regular income portion will be exempt from tax.
Income replacement term insurance is logical as it seems. Really helps if one is uncertain about the future.. According to the ABI, one million workers a year find themselves unable to work due to a serious illness or injury. Such type of insurance is definitely a way to go.
Dear Mr. Deepesh,
thank you for the valuable information. I am 34 years old. This is the first time i am hearing about Income Replacement Term Insurance Plans.
I have a LIC policy for 5,00,000 and I am paying approximately 25000 in an year from past 4 years. I no longer want to continue this policy and would like to take one term insurance plan for an amount of 50,00,000 after reading you blog.
Could you suggest be better term insurance plan? Also, suggest me whether I can purchase online or search for an agent.
thank you
Hi Satya,
Income replacement term plans are no special plans. The difference lies only in the way the payout is made.
You can go with any insurance company. There is not much to differentiate between term insurance plans.