My friend Nikhil called me recently to enquire about a free offer. He got an offer of 1 Lakh health insurance free while signing up for a new credit card. I told him to ignore this. Though he is having enough cards, he opted for a new one just to avail this free offer! When he got the first month statement of the card, he was surprised to see a debit of Rs. 3500/- towards the cost of this ‘free health insurance’’!
After this incident, he met me for a financial planning discussion. To my surprise, he is holding 6 Credit Cards. I told him that his CIBIL Report will be affected due to this. This can later affect his loan eligibility also. I asked him to cancel the 5 and keep only 1 and use it carefully by paying the actual amount due every month. Credit cards carry the highest rate of interest rates in the range of 36% to 48%.
Avoid Complex Life insurance – They are traps with no escape route!
We discussed all his investments/ insurance and the findings were alarming. Last year he was invited with spouse by a Venue Marketing Team by offering 1 Lakhs personal accident insurance free to attend their meeting. At the end of the 1 hour discussion, he was almost forced to buy a ULIP Policy for an annual premium of Rs. 50,000/-.I told him that the actual cost of this free policy is only Rs.30/-. This particular ULIP policy was having huge entry charges and after realizing the details, he has decided not to pay any more premiums in future. A Loss of Rs. 50, 000/- for going for this Rs. 30/- free offer! Venue marketing has become the worst selling mode in life insurance.
Last month, he has taken an NAV guaranteed policy and just paid one quarterly premium. These policies are another marketing gimmick and will offer returns like any debt instruments only. The charges are very high and this will reduce the number of units every month and your fund value will go down. The company deducts charges under mortality charges to provide the insurance cover, guarantee charges to offer the guarantee, administration charges to administer the scheme, entry charges to pay commission and other expenses. All these charges will reduce your number of units considerably and even if you are getting the highest NAV, your reduction in number of units will bring down your returns. At the end of the discussion, he has decided to drop this policy too!
He told me that his uncle, who is an insurance agent, is persuading him to go for an endowment policy. The same uncle was recommending ULIPs last year! Why endowment has become so good now? After the recent IRDA regulations, commission on ULIP has come down and now endowment is best not for you but for your Uncle! Some policies still have commission upto 40% in the first year! The actual return on an endowment policy will be around 5%, that too on the long term. Even Savings bank offers now 4% return! Luckily he has not taken this policy. He told me that he has to manage his uncle without hurting their relation. Such obligations are the biggest problem in life insurance selling.
Term Insurance – The best bet, but your agent will not sell it.
Recently, he heard from somebody that Term Insurance is very good but he was skeptical about it, because, there is no maturity benefit! I asked him, what you feel, if there is no claim on your car insurance in a year? The only way we can get returns in Term Insurance is to die. So, if there are no returns in a Term Insurance policy, you should be happy that you are alive! Then why we should go for this policy? This covers you for a higher amount at a cheaper premium. If you are aged 30, you can cover your life for 1 Crore on a 25 year policy for an annual premium of Rs. 8000/-. Only such policies will really help families in times of needs. Savings linked products are beneficial only to the agents. So treat insurance premium as an expense and not as a savings. Buy term policies for insurance cover and invest the balance for better returns. Nikhil was about to call his uncle for a new Term policy, but I told him to go for online policy where premium is much lower. He has decided to go for a cover of 1.25 Crore.
Mutual Funds – Ideal for retail investors for long term financial goals.
He asked me whether he can invest in shares, even though he doesn’t know the ABC of Mutual Funds. Being a College, lecturer, he is busy all the day and he cannot track the market movements. I told him the risk associated with it. There are so many difficulties in selecting the right stock at the right price. Satyam Computers was a top rated company by analysts even 1 week before the collapse! I told him to invest in Mutual Funds through the SIP route which will help him in getting the rupee cost averaging and professional fund management. World over mutual funds are accepted as the best instrument for long term wealth creation. It is tax efficient also, because equity mutual funds can be sold after 1 year, without any tax implication.
Tax Planning under Sec. 80C
He asked me on tax planning for this year. I found out that he is having a PF recovery of 36,000 pa and paying Rs. 20,000/-premium for some old LIC policies. Now he is planning for a Term insurance with Rs.10, 000/- premium. He is not aware of the fact that tuition fee also can be claimed under Sec. 80C. He is paying around 48,000/- as tuition fee for his children. With this he has his maximum eligibility of 1 Lakh under sec. 80C. I told him that, the situation will change from next financial year, when the Direct Tax Code kicks in.
As per the Direct Tax Code (DTC), you will get exemption upto Rs.50, 000/- pa only under this group. This group consists of Life Insurance premium, Health Insurance premium and Tuition Fee. In his case, the tuition fee alone will be more than 50,000/- next year, resulting in no income tax benefits for the Life insurance premium and health insurance premium! You can get exemption upto 1 Lakhs for investments in EPF, PPF, and NPS.
He is bit tensed now and want to do a retirement planning. I told him to do a calculation of his likely pension, PF and Gratuity receivable on retirement. This analysis revealed that, there will be a shortage of Rs.50 Lakhs on his retirement to maintain the same standard of living. He can create this with an SIP of around Rs. 1500/- pm in the next 30 years. Otherwise, he can manage this by going for a Reverse Mortgage on his Flat. Thanks to his father, he inherited a decent flat, which helped him from not going for a flat under home loan.
Now, he wants to make provision for his two children for education and marriage. He is having some decent gold and silver investments. I told him to arrive at the present cost of education and marriage and find out the inflated value. We then calculated the solutions for each of this requirement. He has to start SIPs of Rs. 10,000 for these goals.
I asked him whether he is having a health insurance. He told he is having a cover from his employer. I advised him to go for a family floater policy in his personal capacity, because this will be helpful for him when he is changing the jobs and more importantly after retirement. He accepted the idea.
He summed up the actionable.
1. Discontinue the ULIP and the NAV guaranteed policy (with great difficulty!)
2. Buy Term Insurance worth 1.25 Crore for an approximate yearly premium of 10,000/-.
3. Buy a family floater health insurance for 3 lakhs sum assured.
4. Start SIPs of Rs. 10,000 in top performing Mutual funds with good track record.
5. Start another SIP of Rs. 1500/- for his retirement shortage.
I added one more actionable. Don’t run after any free offers!