Term Insurance vs Traditional Insurance – Which is better?

You have decided that you need to purchase insurance to protect your family. Great step. We congratulate you for taking this first step in securing your family’s financial future.

But when you move out in the market searching for the right insurance plans, you must have some basic understanding of insurance. Otherwise, you can get confused by terms like term life, endowment, whole life, surrender, freelook, etc…

And you may end up buying the wrong insurance, which can mess up your financial life big time.

We are here to help you avoid such mistakes to select the right plan. This post explains 4 core differences between a term insurance plan and a traditional insurance plan and guides you on which insurance you should choose as a young investor.

Difference # 1: Pure Risk Coverage vs Investment

This is the most essential difference between term insurance and traditional insurance.

Term insurance is pure risk coverage. The premium you pay goes completely towards covering you for the risk of dying. So, there is no investment component in the premium. So your family members get the money when you die. If you live till the end of the insurance period, you do not get anything.

Contrary to that, traditional insurance plans are essentially investment products that have a small insurance component. The premium that you pay is divided into risk coverage and an investment component. The investment component gets invested in mainly fixed income products as per government regulations.

Like term insurance, here also if you die, your family members get the money. But the big difference is that if you are alive by the end of the insurance term, you still get the money.

Difference # 2: Level of Insurance coverage vis-a-vis the premium cost:

In term insurance, since there is no investment component involved, the premium is very reasonable.

As compared to that, in traditional insurance, since there is an investment component involved, the premium for the same sum assured & for the same age is much higher, sometimes even 4-5 times.

Let us take an example. A 1 crore term life insurance plan for 30-year-old male costs around INR 12,000. For the same coverage, a traditional insurance plan will cost around INR 70,000. This means that for the same life insurance cover, you end up paying 6 times more!

Difference # 3: If you close the policy early

In term insurance, if you stop paying future premiums, your life cover gets stopped, simple. This means that if you die after the grace period for paying the premium is over, your family will not get any money.

On the contrary, traditional insurance is highly rigid, and the rules on surrender are very complicated and burdensome. Since traditional insurance has an investment component, there is a penalty on early closure.

If you surrender in the initial years, you get only a minimum guaranteed surrender value of around 30% of the premium paid. The only way to get some emergency money from the policy is to opt for a loan on the surrender value, which is not a wise option considering the interest charges.

Difference # 4: Tax Treatment:

In both term and traditional insurance plans, the amount that the nominee receives on the policyholder’s death is totally tax-free in the hands of the nominee. However, the situation changes in case of survival benefit.

In term insurance, there is no concept of survival benefit. However, in the case of a traditional insurance plan, survival benefit is fully taxable if premium paid is more than 10% of the policy’s sum assured. If the amount is taxable, there is a TDS @ 1% applicable if the amount is more than INR 1 lac.

OUR VERDICT: Which insurance is right for you?

At Finbingo, we recommend young investors buy low cost and transparent products that save tax & also help create long term wealth.

In our view, traditional policies are highly inefficient products. Young investors must try & resist the temptation to invest in these products if they want a hassle-free & straightforward financial life. Instead, young investors should choose pure term insurance for their insurance needs.

Our reasons for preferring term insurance are as follows:

  • Remember the golden rule – “Never mix insurance with investment”. By buying traditional insurance, you get the worst of both worlds – neither sufficient insurance, not decent returns from your investment.
  • Term insurance allows you to buy a higher life cover at a fraction of the cost. This is really helpful for young investors who have dependants & want an affordable solution.
  • Term insurance comes at a very affordable cost. And that is why it frees you to invest in low cost, transparent & tax-efficient products like ELSS, which help you create long term wealth.
  • It is easy to get into a traditional policy. But once you are in, it is complicated to get out due to the lock-in, high surrender charges, and tax implications.