What is Term Insurance? : Complete Guide for Beginners

Aditi is not alone. Many people are often overwhelmed by the sheer number of life insurance types and categories. Life insurance can be broadly categorized into endowment plans (conventional) and term insurance with further sub-classifications. This blog will simplify term insurance concepts for beginners to help them make an informed financial decision.

What is Term Insurance?

A term plan is a type of life insurance that provides a financial blanket to the nominees of a policyholder in the event of their untimely demise during the insurance term. Typically, a term plan is an expense in a policyholder's hands as it protects them with no maturity benefits (except a term plan with a return of premium).

For Aditi, as a 26-year-old individual, a term plan can be an excellent choice as the premiums would be quite low with a significant sum assured. If Aditi’s annual income is ₹ 10 lakh, she should opt for a term plan that offers a ‘sum assured’ of at least 8-10 times her income, which should be close to ₹ 1 crore. She must pay an annual premium of ₹10-12 thousand* (approx.) for the term plan.

Why should you buy term insurance?

The most obvious answer is to have financial security for your loved ones in your absence. There are numerous planned and contingent obligations that your family might need to take care of. With a considerable amount of money, you can help to protect their future. In addition, here are some other reasons:

1. Term insurance offers high coverage at affordable premiums.
2. Premiums paid qualify for tax deduction u/s 80C of the Income Tax Act, and any death benefit is also tax-free u/s 10(10D).
3. There are numerous additional riders, such as critical illness, permanent disability, and accidental death, which can be added to a term plan.
4. Better financial planning and peace of mind for the policyholder.

What are types of term insurance?

Widely, the term insurance plans are available in four categories:

1. Level Term Plans: The basic plans where the sum assured is constant throughout the policy coverage period.
2. Return of Premium Plans: The policyholder receives a refund of the total premium paid if they survive the term. The premium is considerably higher than that of level term plans.
3. Increasing/Reducing Term Plans: In increasing plans, the sum assured grows annually to match inflation or rising financial needs. Decreasing plans reduces coverage over time and is suitable for covering liabilities like home loans.
4. Group Term Insurance: Such plans cover a group of people, usually company employees.

Coming back to our example: Why should Aditi opt for a level term plan when the return of the premium plan appears better?

Prima facie, the return of premium plan, is better. However, if Aditi decides to pay a lower premium by opting for a level plan and reinvests the savings in Nifty 50, here is what her situation would be after the policy term:

It purely depends on the personal financial planning of an individual as to which alternative is selected. Each option has its merits, and the eventual decision should be informed and based on data.

How to Choose the Best Term Insurance Plan?

There are several insurance companies offering a wide range of personalised products suited to your needs. You need to check the following things before making the decision:

1. Assess Financial Requirements: The ‘sum assured’ should be based on proper calculations such as current income, family expenses, outstanding loans, and future financial goals. Ideally, it should be at least 10 times the annual income.
2. Evaluate Coverage: You must ensure that the policy term aligns with your earning years and covers all dependents until they become financially independent.
3. Check Claim Settlement Ratio: Choose a company with a higher claim settlement ratio. Select an insurance company with a ratio as close to 100%.
4. Compare Offers, Riders, and Premium: Carrying out a comparative analysis of the options available always helps you make a correct decision.

Summing Up

To sum up, having term insurance can be a significant step in your journey to financial independence. For first-time buyers, it is critical to start early as premiums are significantly lower during your mid and early 20s. You also get numerous offers and flexible premium-paying terms based on your history.

Understanding your family’s financial situation and fixing the ‘sum assured’ coverage is important. Based on your risk appetite and financial goals, you can choose ROP (Return of Premium) or level term insurance plan.