As we approach tax season, it is imperative to consider the critical link between tax planning, insurance planning and overall financial well-being. Often, in the rush to meet investment-proof requirements, individuals hastily purchase insurance products solely for tax benefits, neglecting a thorough analysis of their financial situation and actual insurance needs.
Unfortunately, this hurried approach can lead to suboptimal decisions; driven by factors such as peer influence or agent recommendations, rather than aligning with one’s unique requirements.
Example:
“My colleague bought this policy, so it must be good for me.”
“My agent recommended this product, so let me purchase it quickly.”
Purchasing insurance solely for tax breaks without considering its long-term implications can result in the following;
- inadequate coverage,
- disproportionate premium outflow, and
- potential financial constraints.
To avoid these pitfalls, it’s crucial to pause and prioritise emergency planning as part of a holistic financial strategy. Consider insurance products as essential components of emergency planning, and view tax benefits as secondary, yet valuable, by-products.
Two protection plans that are essential for Personal Finance needs
Term Insurance:
Consider purchasing an adequate term insurance policy to secure your family’s financial future in the event of premature death. This provides them with the necessary financial support which will act as a safety net in your absence. Although the primary purpose of term insurance is for emergency planning, it also provides the added advantage of tax benefits.
Premiums paid for term insurance are deductible under Section 80C. The maximum amount that can be deducted for term insurance premiums is ₹1.5 lakhs per financial year. Please note that this limit of ₹1.5 lakhs is inclusive of various other investments and expenses eligible under Section 80C, such as Public Provident Fund (PPF), Equity-Linked Savings Scheme (ELSS), National Savings Certificate (NSC), principal repayment of home loan, etc.
Moreover, the payout received from term insurance is tax-exempt under Section 10(10D), providing double benefits – financial security for your family and tax savings for you.
Health Insurance:
When selecting a health insurance plan, it’s crucial to ensure comprehensive coverage for hospitalisation needs, not just for yourself and your family, but also for your elderly parents, who may have more significant medical needs. A good plan should cover a wide range of medical expenses including hospital charges, doctor consultations, and pre-and post-hospitalization costs.
Similar to a term plan, the primary objective of a health insurance plan is to provide financial security and save dents in your pocket in case of medical emergencies. However, an added advantage of a health insurance policy is that it offers tax deductions, enhancing its value as a financial planning tool.
Under Section 80D of the Income Tax Act, individuals can claim deductions on the premiums paid. The allowable deduction is up to ₹25,000 for the insurance of self, spouse, and dependent children. Additionally, if you are insuring senior citizen parents, you can claim an extra deduction of up to ₹50,000.
Rightly chosen insurance coverage offers dual benefits – it safeguards your financial health against unforeseen circumstances and also provides peace of mind. When strategically purchased, it not only provides the necessary safety net but also significantly reduces your tax outgo, aligning with both your financial security and tax-saving objectives.
Points to remember while buying an insurance policy
The foremost purpose of insurance is to ensure that your family is financially secure and can maintain their standard of living in the event of an emergency, making it a key component of a well-rounded emergency plan.
It’s important to recognize that while tax benefits under various sections of income tax for premiums paid towards them are indeed beneficial, they should not be the driving factor in your decision-making process. These tax savings are better viewed as a supplementary benefit.
Hence, when it comes to selecting an insurance plan, your primary consideration should be the level of coverage necessary to fill your requirements adequately, act as an income replacement or help you save out-of-pocket expenses in case of medical emergencies. Shortly, Life and Health Protection is the key or first step towards a financial planning journey.
Factors like your current financial situation, your dependents’ future needs, outstanding debts, and long-term financial goals should guide your decision on the coverage amount.
Know your tax regime:
If you want to maximise tax deductions using insurance instruments, the old regime is generally more beneficial, as it offers numerous deductions for investments.
Don’t mix insurance with investment
When planning to buy an insurance product, remember that saving money and protecting yourself with insurance are two different things. It’s not a good idea to mix them up.
Insurance, particularly life and health insurance, is fundamentally a safety net. Its primary purpose is to provide financial protection against unforeseen events such as illness, accidents, or death. The aim is to secure your and your family’s financial stability in case of emergencies. When you purchase insurance, the focus should be on getting adequate coverage to ensure this safety.
Mixing the two – such as buying insurance products that promise investment returns – can lead to suboptimal outcomes.
Beware of mis-selling:
Agents chasing targets might not always have your best interest at heart. One common mistake to avoid is mis-selling, where agents prioritise commissions over your best interests. Be cautious and prioritise insurance products that truly add value to your financial security.
Leveraging scoring and ranking model
Choosing the perfect insurance policy that aligns with your specific needs can be challenging. However, there is a smart way to evaluate plans and identify the optimal product for you objectively – use the Scoring and Ranking model by 1 Finance.
This model acts as a search engine for you which provides transparent metrics and provides 1 single numeric in the form of 1 Finance score to rely on.
To wrap up
Given the complexities that come with insurance policies, choosing an insurance policy that completely aligns with you can be overwhelming. Hence it is always advisable to consult with a Qualified Financial Advisor (QFA) who can provide you with a holistic financial plan covering the key components such as Emergency planning, Insurance Planning, Tax strategies, Assets allocation and Diversification, Will and estate planning and tax implications and helps you transition from being financially independent to financial freedom and a peace of mind.
