Insurance as the First Step in Financial Planning – Forbes Advisors India

Financial planning simply means that you need to take charge of your finances. In this you include charting of your income, expenses, assets, liabilities along with your financial goals. Next, you build a financial portfolio and invest in a variety of avenues to meet your goals. With the advent of high inflationary expenses and rising cost of living, insurance seems inevitable, especially with the shift towards nuclear families in India.

As a first step towards creating your financial plan, you need to identify your goals, their horizon and your disposable income (income – expense). You then need to allocate your disposable income across different investment avenues to build a corpus for goal fulfillment. However, of all your plans, where does insurance fit in? The question you may need to answer is is insurance important, and if so, how important?

To protect your family from any kind of financial stress in your absence, insurance plays an important role. Insurance acts as your safety net and this is why it may be a good time to consider taking an insurance plan.

Importance of insurance in financial planning

Insurance as a product is beneficial to protect your finances. Here are some of the reasons that make insurance the best part of your financial portfolio:

1. Risk Coverage

Insurance is a risk mitigation tool. Hence, it prepares you to face financial loss in case of any unforeseen event like death or hospitalization.

2. Financial Security

Insurance policies provide financial protection by indemnifying you in case of an emergency. You are safe in the knowledge that if an emergency occurs, the insurance policy will suffer a loss. This helps you plan your finances and build a corpus for your goals. It also ensures that the funds employed are safe and are not used in case of emergency.

3. Different plans for different needs

There are different types of insurance plans to cover the different types of risks that you may face. Life insurance policies cover the risk of premature death while health insurance policies cover medical emergencies. Similarly, motor insurance plans cover the risk of road accidents or vehicle theft and travel insurance plans cover travel-related contingencies.

Thus, you can choose different policies based on the risks you face and create a 360-degree layer of financial protection.

4. Tax Benefits

Life and health insurance plans are tax-saving as well. Life insurance premiums are eligible for deduction under section 80C while health insurance premiums are eligible for deduction under section 80D. Both these deductions help you reduce your taxable income by Rs 2.5 lakh (up to Rs 1.5 lakh under section 80C and Rs 1 lakh under section 80D). If you fall in the 30% tax bracket, this deduction helps you save Rs 75,000 in tax.

Moreover, under life insurance plans, the death benefit is completely tax-free. Even the maturity benefit is tax-free (subject to specific terms and conditions) under the provisions of section 10(10D). This means that by investing in insurance plans, you can plan for your taxes as well.

5. Peace of Mind

Insurance plans give you peace of mind knowing that your savings will not be at risk in case of an emergency. This gives financial freedom to you and your family.

Financial planning is a five-step process

According to the financial planning pyramid, derived from Maslow’s hierarchy of needs, the five stages can be classified as:

  1. MANAGE YOUR MONEY: Where the focus is on reducing your daily expenses, debt and establishing steady cash flow
  2. Construction of safety net: where is the focus Build your emergency corpus, grow your savings and opt for adequate insurance coverage – both health and life.
  3. Money accumulation: where is the focus Grow your investment portfolio, retirement corpus and use tax benefits and exemptions efficiently.
  4. Conservation of Money: Where the focus is on enjoying financial freedom by converting retirement corpus into income and maximizing pension income.
  5. Leaving a Legacy: Where the focus is on estate planning, succession and continuity planning along with philanthropy.

These are the five stages of financial planning where insurance comes into the second stage before accumulating money.

Must have insurance plans in your portfolio

The choice of insurance policies completely depends on your needs. You need to assess the financial risks that you face and then buy suitable plans to insure such risks. However, some insurance plans are universally relevant and demand a place in everyone’s portfolio. These plans are as follows:

1. Term Insurance

A term insurance policy is a basic life insurance plan that covers the risk of premature death. The policy comes with a specified term and if the life insured dies during the term, the death benefit is paid.

Term insurance plans are necessary only because death is uncertain. If the breadwinner of the family dies prematurely, the family can suffer a lot of financial loss. A term plan covers such losses. It gives a death benefit to the family so that they can meet their lifestyle expenses and also meet their goals.

Furthermore, modern-day plans have become all-inclusive. You can find various coverage variants that not only protect you against the risk of premature death but also against critical illnesses, terminal illnesses and accidental deaths. You can also choose the whole life option and enjoy coverage till the age of 99 or 100 years.

2. Health Insurance

Health insurance plans prove relevant due to the incidence of medical contingencies and the coverage provided by these plans. A health plan covers your medical bills if you suffer from an illness or have been injured in an accident and need to be hospitalized.

In today’s era, medical costs are rising significantly and are increasingly unaffordable for most families. According to official inflation data, medical inflation rose to 8.4% in May 2021 as compared to 3.8% in December 2019. The report also noted that the cost of drugs increased by 8.6% year-on-year, while medical tests increased by 6.2%. Similarly, hospital fees increased by 5.9%, while consultation fees increased by 4.5%.

In such a situation, it has become necessary to have a health insurance plan. It ensures financial security when there is a medical emergency.

3. Motor Insurance

Motor insurance policy becomes relevant if you have a vehicle. Whether you drive a two wheeler or a four wheeler, a motor insurance plan is mandatory under the provisions of the Motor Vehicles Act, 1988.

Motor insurance plans protect you from the financial liability that you may face if you cause injury to someone else or damage to third party property. The plan takes over the financial liability and compensates for the loss caused to third parties.

In addition, if you opt for comprehensive plans, you also get coverage for damages caused to your vehicle in an accident or any other calamity. The plan also covers theft of the vehicle and provides a one-time benefit to help you replace the stolen vehicle.

These three policies are a must for your financial portfolio and should not be missed. They help you secure your finances in case an emergency arises.

How to choose the optimal coverage

The problem of low insurance is very common in India as the penetration and density are below the global average. Furthermore, when it comes to health insurance, data from the General Insurance Council shows that as of March 2020 and 14. amongth May 2021, policyholders pay 40% of their medical bills out of pocket despite having health insurance.

Numbers don’t lie. First, there is less access to insurance and second, those who have insurance are also completely underinsured. In such situations, buying optimum coverage is as important as buying insurance in the first place. If the coverage is not sufficient, the whole purpose of insurance is defeated.

When buying insurance, it is important to select the optimum coverage. Here are some simple formulas to consider:

  1. term insurance

Opt for a sum assured of at least 10 to 12 times your annual income. For example, if your annual income is INR 25 Lakhs, you need coverage of at least INR 2.5 to 3 Crores.

  1. health insurance

Opt for the sum insured which is equal to 50% of your annual income plus the total hospital bills in the last three years.

So, if your annual income is INR 25 Lakhs and you have been hospitalized in the last three years with a bill of INR 2.5 Lakhs, then your Sum Assured should be at least INR 15 Lakhs.

Remember, these are basic calculations that don’t take other variables into account. Ideally, coverage should depend on your financial needs which can be ascertained from various factors. Some such factors are as follows:

  1. your lifestyle expenses
  2. number of your dependents
  3. current assets and liabilities
  4. Your financial responsibilities or goals

So don’t make hasty decisions while buying insurance. Assess how much coverage you need and then choose the right plan.

ground level

The best laid plans can go awry. Life has a tendency to throw regular curveballs your way. Thus, you need a contingency plan. Insurance is the contingency plan that helps your portfolio absorb the financial shocks of an emergency.

Emergency planning is the first step in financial planning and insurance plans allow you to do this. So, before you create detailed savings and investment plans for your goals, do the basics of an insurance plan. Laying the foundation for secure financial planning, immune to emergencies. Next, start your financial planning journey, plan your portfolio and watch your investments help you meet your goals.

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