Payout is a large sum of money, considered as compensation, dividend, or death benefit given to the beneficiaries of a deceased person if he bought a term insurance policy during his lifetime. When one buys this policy, the insurance company offers the insured to decide a payout option that can be applied during claim disbursal. Experts advise putting enough thought behind picking the payout option. It should be decided on the basis of your dependents’ financial understanding, your current liabilities, and future goals.
According to S.K Sethi, director at Ria Insurance Brokers which has been handling term insurance products for several years, “Selection of a payout option depends on the client’s needs and liabilities towards various loans. If a person has a business loan alongside a housing loan and car loan, then in the event of any mishappening the family will have to take care of these loans on an immediate basis. In such a case, lump-sum payment to the nominee is advisable.”
Why is lump sum the most popular payout option?
The fact that lump sum enables the beneficiaries to receive the entire sum of the death benefit in one go makes it the most popular choice among policyholders. But is it ideal for everyone? Not entirely. This is especially true if the nominee is not financially literate.
“In lump sum payment, there might be chances of sheer foul play by relatives and friends. There are thousands of examples where the money received from the insurer was wasted due to a lack of financial understanding. This can result in dependents suffering in the later years,” Sethi pointed.
Getting a huge dividend can simply result in mismanagement if one isn’t smart enough to utilise the money efficiently. The lump sum if invested in the right direction can ease your financial liabilities. Meanwhile, it can have the opposite impact if the money lands in the hands of a careless individual.
Difference between fixed monthly and increasing monthly pay-outs?
While debt-ridden people are recommended lump sum payouts, those with zero debt can choose the option of annuity in the form of monthly payment (also known as staggered payout). Under this, monthly receipt of funds from the insurance company can be used by the family for meeting the household expenses. This is especially applicable if the wife is a homemaker.
There are two types of staggered payout options, namely, fixed monthly payouts and increasing monthly payouts. So what is the primary difference between the two?
A fixed monthly payout will enable the nominee to receive a part of the sum assured amount as lump sum and the remaining shall be paid as monthly instalments. In case of increasing payout, the payment of the sum assured is executed in the form of increasing monthly instalments.
“Let us be clear that money received in either case will be the same, i.e., sum assured. The annuity (monthly payment or increasing monthly payouts option) will be calculated out of the same. If the fixed monthly annuity is taken, then you’d already know the prevailing rate of interest will be exhausted in how many years (number of years being selected by insured). Similarly, under increasing monthly pay-out, interest rates will be minimum in the beginning and maximum towards the later years and will, of course, dependent on what % increase has the nominee asked for,” Sethi explained.
Role of financial literacy?
The major decision while buying an insurance policy is to choose between lump sum and staggered payment options. However, financial literacy becomes rather critical in the case of lumpsum being received by the nominee.
Sethi feels that “A combination of financial literacy and common sense is important. Even if you take advice from a friend or relative you should know – what is the track record of that person. Is he honest? Is he greedy? Is he in litigation with other persons? What is his relationship with the nominee? A share broker will always guide you to invest in shares for higher returns. But you need to assess the situation. If someone has lost their husband, the person should take a conservative approach and not indulge in risky investments like MLM schemes, chit fund, committees (unorganized chit fund popular in the country ), invest in shares, or give loans.”
As a policyholder, make sure to select the payout option depending on the beneficiary instead of what suits you at the moment. Insurance policies must always be planned from the view of your dependents rather than you.
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