One of the peculiar traits of a Term Insurance Plan is that you have to visualize the life after death “today”. The reason being term insurance plan does not carry any surviving benefits. Therefore, policyholder opts for term insurance plan purely to safeguard the financial future of the family. Based on the queries posted by the readers of this blog, i can conclude that biggest worry of a potential policyholder is whether the sum assured of a term insurance plan will suffice for family or not. I also faced this dilemma.
The financial planners suggest opting for a cover equivalent to 10 times your annual income. Personally, i disagree and addressed this dilemma in my post, Is Life Insurance Cover 10 time your income sufficient for your family. The 2nd major concern of a policyholder at the time of filling insurance proposal form is whether to opt for lump sum payment or staggered payout. Staggered payout is also known as Monthly Income Benefit / Plan. We will discuss this dilemma in this post.
Assuming, i am planning to buy a term insurance plan of Rs 1 Cr. I have to decide whether my nominee will get Rs 1 Cr lump sum upon my death or 50L at the time of death and fixed Rs 50,000 per month for next 10 years. Prima facie, the latter option looks promising. After going through the details and policy wordings & financial calculations i decided against monthly income benefit and opted for lump sum payment. There can be few other options like NIL payment at the time of death and staggered payout of 1L per month for 10 years or 10% increase in monthly payout every year. I have not considered 100% staggered payout options at all that i will discuss later in the post.
Just to clarify that as i will not get this money in my hand so there are NO Vested interests behind my decision :). Also to caution readers that this decision is irreversible. In other words, you cannot change the option from lump sum payment to monthly income benefit or vice versa once the insurance company accepts the proposal form.
Term Insurance Plan – Why You Should Not Opt For Monthly Income Benefit
1. Financial Calculations:
I avoid sharing any financial calculations until unless absolutely necessary as it confuses most of the readers. The reason being, the financial calculations may vary from case to case basis. Therefore, i prefer to share the general conclusion that is universally true. In the case of a term insurance plan, the conclusion is that it is financially beneficial to opt for lump sum payment instead of monthly income benefit :).
The life insurance provider pitches the monthly income benefit as the beneficiary will receive 1.1 Cr instead of 1 Cr. I agree but policyholder fails to calculate the annual returns in this case. For example, in the illustration shared by me if my nominee receives 50L at the time of death and 60L is staggered over 10 years then what will be annual return in this case. In such a scenario, i will prefer that my nominee should receive a 50L lump sum at the time of death instead of 60L staggered over 10 years.
As each and every plan evaluated by me was different but on an average tax free annual return was 5% under monthly income benefit options. In my opinion, it is too low. I am confident that my nominee / beneficiary can generate better returns on lump sum payment.
2. Misleading “LOW” Premium:
Assuming the sum assured remains same i.e. 1 Cr. In certain term insurance plans, the premium is same whether you opt for lump sum payment or monthly income benefit. You should not think twice and opt for lump sum payment under such plans. In few instances, the annual premium of 100% staggered payout term insurance plan was approx 15% to 20% less than lump sum payment. It looks quite an attractive option as the policyholder will save the premium upfront.
In such cases, please remember that lump sum payment at the time of the death of the policyholder is NIL. Therefore, insurance company passes part of financial benefit due to 100% staggered payment to the policyholder by way of discounted premium. Again you need to calculate the net return as i explained in point no 1. Under any circumstances, the annual tax free return under staggered payout will not exceed 7% compared to lump sum payment in term insurance plan. Therefore, you should not decide on a particular plan just based on the premium.
3. Death of a Nominee or Beneficiary:
For a minute we assume that monthly income benefit option of a term insurance plan is more beneficial for you. In such cases, the benefit period extends from 10 years to 15 years. Now what will happen if the nominee or beneficiary of the term insurance plan dies during this period? The whole purpose of availing term insurance plan by the original policyholder is defeated. The 100% benefits of the term insurance plan were not passed to the family.
On the contrary, if 100% sum assured was paid as a lump sum amount to nominee or beneficiary at the time of the death of the policyholder. Upon the death of nominee, the unused funds will be inherited by the legal heirs / beneficiary of the nominee. In the majority of cases, these legal heirs / beneficiary are the children of the original policyholder and nominee is spouse.
Also Read: Insurance – Top 7 Excuses
4. When you need the money most?
The answer is the beneficiary or nominee need the money most at the time of the death of a policyholder. In almost all the cases, the nominee is either husband or a wife. The death of a spouse is the most stressful event of a life according to one study. On a scale of 100, it is rated 100. The financial situation becomes grim in the case of non-working nominee / beneficiary. Moreover, the beneficiary / nominee may require money to clear any running debts / loans / outstanding amount etc on a priority basis that we will discuss in next point. If the payment at the time of death is NIL then the nominee may find himself / herself in financial distress. Because of this reason, i out-rightly ruled out 100% staggered payout / month income benefit term insurance plan.
It is always advisable to include your term insurance plan details in your WILL. Preferably, the nominee of the term insurance plan and the beneficiary of the WILL should be the same to avoid any dispute. If you have the plan to clear huge liabilities like home loan etc from the proceeds of term insurance plan then the lump sum payment is the best option. You can mention in your WILL that the beneficiary of the term insurance plan will be responsible for clearing the liabilities of the policyholder / Testator and retain the net proceeds.
I covered this topic in detail in the post, Who is responsible for clearing the loan liabilities of a deceased borrower?
Words of Wisdom:
There is a famous proverb that “A bird in the hand is worth Two in the Bush”. The objective of insurance is to provide immediate relief to the family because of sudden loss of an earning member of the family. In my opinion, if someone tells me to opt for monthly income benefit is like suggesting me to take care of 10-15 years financial planning for my family after my death.
I was scared by the financial planner that your nominee will not able to manage lump sum amount etc and it is better to go with monthly income benefit. I told him that it is okay. He need not worry and i also need not worry. I can control my finances only till i am alive. Asking me to worry about what will happen after my death is too much to ask from an individual. Under Section 45 of the Insurance Laws (Amendment), no claim can be rejected after three years for any reason. Therefore, i am assured that coverage amount will be paid to the nominee and after that, it is his / her choice how he / she would like to utilize the proceeds of term insurance plan.
Please note that examples shared in this post are only for illustration purpose.
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