Buy life cover if you have dependents

Sameer felt like he was living a dream, when at 23, he got a campus placement in a multinational company after completing his management studies. Being the only son of well-to-do parents, he didn’t have any immediate family obligations and started spending with élan. Clearly, saving money was the last thing on his mind.

Life went on, until he met Prakash, an old friend who had decided to make a career out of the booming insurance sector. Minutes into their meeting, Prakash started canvassing the merits of life insurance, listing out benefits such as convenience, safety and the various sops offered by existing policies.

He told him how an early start would give him an edge, considering the mortality costs are lesser and hence, the premium, too. Prakash insisted that his friend buy a term cover, which is the cheapest form of insurance, and then think of investing in insurance.

Sameer saw sense in whatever he said, but remained undecided on whether he should opt for a cover right away or wait till he had dependents.

A senior colleague advised him to seek professional help from Vishwas, a well-known financial planner. When Sameer told him of his dilemma and laid out the comparative tables provided by Prakash on the premiums payable now and five years later, Vishwas smiled and agreed that this was a common dilemma that often went unclarified.

Vishwas held that making available a lump sum to one’s dependents to help them overcome the financial loss in his absence was the right perspective to be adopted for life insurance. According to him, Sameer required no life insurance as he had no dependents and that the ideal time for the young MBA to buy a cover would be when he was married, which would be 4-5 years later.

But, what would be the cost of deferring his insurance cover by so many years?

The financial planner laid down a table for easier understanding.

Vishwas pointed out that the decision to defer life insurance by five years would cost him Rs 58,500 for a cover of Rs 25 lakh and Rs 1.17 lakh for a cover of Rs 50 lakh.

“Isn’t that a big amount to lose?” asked Sameer.

“On the face of it, yes. But, you can make it up by starting to invest now,” said Vishwas. “Let us say you put the amount you would have paid as premium, i.e. Rs 6,250 per year, for the next five years. The savings account would fetch you 3.5% per annum interest today. At this rate, your investment of Rs 31,250 would have grown to Rs 33,515 at the end of five years. At that point, you take the insurance policy for a cover of Rs 25 lakh and stop putting money in the savings account. In other words, you let the Rs 33,515 balance in your savings account compound for the next 30 years (the tenure of the policy) at an assumed 3.5% per annum. At the end of your policy period, this amount would have amounted to Rs 94,000, well over the extra Rs 58,500 you pay for starting the policy late.”

“Similarly, you can accumulate Rs 1.88 lakh by depositing Rs 12,500 per year for five years in the savings account and letting it compound thereafter. That would be well in excess of the Rs 1.17 lakh difference you will pay by starting the policy five years hence.”

“I am sure you understand this is an extremely conservative option. The corpus would be much higher if you swapped the savings account with a public provident fund account, which guarantees a return of 8% per year now. By the time your policy matures, you would have accumulated Rs 3.69 lakh and Rs 7.38 lakh, respectively, for the two premium amounts mentioned earlier.”

There are options galore, really. A recurring deposit of Rs 650 per year for 35 years, at an interest of 5% per annum, would accumulate Rs 58,750. Put the same amount in a PPF account every year and you accumulate Rs 1.12 lakh at the end 35 years,” Vishwas explained. “The returns would be exponential if you invested in equities for that long a timeframe.”

This was an eye opener for Sameer. The discussion on insurance had somehow taught him the value of investing early in life so as to reap the benefit of compounding, said to have been described by Albert Einstein as the “the most powerful force in the universe.”

Note: The premium and the coverage figures used above are purely for representation purposes. The premium quotes have been obtained from the website of a leading life insurance company.

Source:
Arvind A Rao / DNA MONEY