Insurance as an estate planning tool
27 December 2015
In India, insurance is largely bought for tax exemption and investment. Actually, it is a risk product, meant to protect the policyholder and his or her family from uncertainties such as death, illness or disability as a result of accidents, etc. Or to provide a replacement for income in case of loss of a job.
And, it is also possible to use it for passing on wealth to your heirs, something high net worth individuals (HNIs) are slowly adopting.
There is a trend of HNIs purchasing life insurance policies. "We find protection plans being purchased by HNI businessmen that extend beyond 60 years, at times up to 80 years. They buy insurance not only for protection, but to address the need for legacy transfer," says Deepak Mittal, managing director, Edelweiss Tokio Life Insurance.
For instance, in the case of one son or daughter inheriting the business, the father might utilise a part of the profits from the business to buy insurance policies aimed at creating an estate for other siblings or dependents. The policies could range from whole-life plans, unit-linked plans (Ulips), endowment plans to non-participating or participating plans.
Typically, they buy a set of policies across a set of insurance companies in order to ensure diversification. The policies will have varying terms. The premia vary between Rs 2.5 lakh and Rs 10 lakh and the sum assured between Rs 25 lakh and Rs 1 crore each.
"We have observed that businessmen buy across seven to 10 policies; sums of Rs 5-10 crore could be set aside for their heirs as the policies over time," Mittal says.
These could be policies where the premium paying term is limited but the coverage extends for a longer time, such as a single premium policy. "A single premium life insurance is a good option through which HNI customers can invest their mass wealth for paying a single premium, which will create an immediate death benefit and transfer the wealth to their next generation after them," says Naval Goel, founder, PolicyX.com, insurance aggregator.
Since life insurance is one of the few financial products that are long-term, it would be a good idea to include a component in succession planning, says Parag Mathur, general counsel at BankBazaar.com. It can be done by a combination of term plans, which are cheap and provide substantial cover in case of death of the insured, traditional endowment plans and Ulips. Endowment policies, though expensive when compared to term plans, allow you to plan for events in your and your successor's life, providing a life cover at the same time.
"You can plan in advance and tie your returns from the policy to major milestones. This is the biggest benefit of including insurance in succession planning. However, make sure you understand the premium utilisation, charges involved, and guarantees provided by the insurer, before you purchase a policy. These factors decide your returns. If you misjudge these, your policy might not prove as beneficial as you thought it to be," says Mathur.
The biggest benefit of using life insurance policies to pass on wealth is the advantage of the tax shield. "Returns in the form of interest, dividends, and capital gains are sheltered from tax. Therefore, you can transfer the wealth without the burden of the tax," Goel of PolicyX.com says.
Not only the maturity proceeds but the premium invested also gets tax benefits, notes Mudit Kumar, appointed actuary, Bharti AXA Life Insurance.
"The benefit of using insurance for creation of assets or for passing on wealth is that beside the maturity value, the policyholder gets life cover for the entire policy term. Investing in a fully funded policy can also provide income to the purchaser, by surrendering the policy for its cash value. Policyholders should develop a strategy before investing, as on how much to invest (one must not overfund the policy and should save for their own purpose as well) and in which instrument," Kumar says.
Conditions to note
Policyholders have to careful about the nomination in such cases. Through the nomination, it is possible to differentiate between the legal inheritor and other inheritors. "The nomination concept will ensure there are less chances of any dispute arising as the nominee details are clear," Mittal says.
While buying an insurance plan, a policyholder should keep in mind that maturity proceeds of the policy are aligned to meet his own financial objectives. He should also be aware of the premium payment term, affordability of paying the premium every year and risks involved in the policy, plus the consequences of discontinuing the premium payment. He should also make sure the nominee details are correct and complete, Kumar adds.
Insurance companies offer whole life plans as products specifically meant for passing on wealth to heirs. Such plans offer two payments. One sum assured, along with the bonus and other benefits, is paid as survival benefit at the end of the policy term. In addition, there is another sum assured for the entire life. Recently, Reliance Life Insurance launched a Lifelong Savings Plan. HDFC Life and IDBI Federal are some others with similar products.
The idea is that customers can buy the plan at 30 years of age, when premia are lower, enjoy cover for their entire lives and leave some money for their families when they pass away, not possible in a pure term plan. But, if you compare costs, whole life plans are costlier than pure term ones. The returns don't justify the high premia, which is why financial planners don't advise such plans.
"In a whole life plan, you get both maturity and death benefit. Since both events are a certainty, the premia are higher. Other policies may not have both benefits together and consequently have lower premia," says Gaurav Roy, co-founder and operations head at BigDecisions.com, a personal finance advice platform.
The entire bucket of insurance policies being used for estate planning is not very prevalent in India, though there is a provision for doing it by assigning the policies under the Married Women's Protection Act, says Roy. A policy assigned under this law effectively shields the proceeds from claims by any other party like creditors or banks and ensures the proceeds are divided only among the nominees. One can assign any kind of policy, term plan, traditional or Ulip under this Act.
"Although the name is Married Women's Protection Act, you can include your wife and children under it as nominees. But once it is assigned under this Act, the policyholder may not make any further changes to it since it is not the property of the policy holder any longer," Roy notes.
It is due to this rigidity and partly due to lack of awareness about this clause that not many take advantage of it to pass on their wealth. It also requires the policyholder to fill up an additional form while purchasing the policy. As the policyholder can decide how much of the proceeds should be assigned to each nominee, it can be effectively used for passing on your wealth and ensuring no disputes.