Lumpsum vs Monthly Payouts. – Which Should You Choose?

When you are the sole breadwinner of your family, and you want to ensure their financial security in case of your untimely demise. This is where a term insurance policy comes into play. It offers a lump sum amount to your family, known as the death benefit, in the event of your death during the policy term. But have you ever wondered whether a lump-sum payout is the best option for your loved ones? In this blog post, we will dive deep into the topic of lump-sum versus monthly payouts in a term insurance policy and help you make an informed decision.

The Dangers of Lump-Sum Payouts

Many policyholders opt for a lump-sum payout without considering its potential drawbacks. Let us say you have a term insurance policy that provides a sum assured of Rs. 1 Crore to your family. If they receive such a large amount all at once, there is always a risk of misusing or mismanaging it. They might overspend on immediate expenses like funeral arrangements or other extravagant purchases, leaving them financially vulnerable in the long run.

If the nominated family member lacks financial planning skills or spends impulsively, the purpose of saving up for your descendants’ future could be rendered useless. To address this concern, insurance companies now offer staggered payout options for term insurance policies. It is crucial to evaluate the term insurance benefits to select a term insurance policy that offers the flexibility and security your loved ones deserve.

Staggered Monthly Payouts – Ensuring Financial Stability

Instead of receiving the entire sum assured as a lump sum, you can choose staggered payouts that provide regular monthly income to your family over an extended period. These monthly instalments act as a steady source of financial support and prevent the risk of mismanagement associated with lump-sum payouts. Let us explore the various combinations of staggered payouts that insurance companies offer:

Initial Lump Sum + Monthly Income

In this option, your nominee receives a high proportion of the sum assured as an immediate death benefit, followed by smaller monthly payments from the remaining amount. The initial sum can range from half the guaranteed amount to 75% of it. The subsequent monthly income serves as financial assistance to your family, helping them maintain their standard of living. However, they must handle the initial lump sum wisely to ensure long-term financial stability.

Balanced Lump Sum + Monthly Installments

Here, half of the assured death benefit is paid as a lump sum upfront, and the remaining amount is provided in monthly instalments to your nominee. This option strikes a balance between lump-sum and staggered payouts, making it suitable for those who are unsure about their family’s financial planning capabilities. The initial lump sum can cover immediate expenses like funeral costs or impending weddings, while the monthly income ensures regular support for your family’s upkeep.

Increasing Monthly Payouts

The third option involves total staggered payouts with increasing monthly income by 10%-20% every year. This increment caters to factors like inflation and changing financial needs over time. For example, if your nominee is a child who will eventually become a college student, they may require higher monthly allowances in the future. Opting for increasing monthly instalments safeguards against inflation and ensures that your family’s financial needs are met throughout the policy term.

Choosing the Right Option for You

Here are some factors that can guide your decision-making process:

Overall Return Perspective: If your term insurance policy extends beyond a decade after your death and you have children, an incremental plan may be ideal to combat the impact of inflation over time.

Financial Literacy: If your family is unfamiliar with complex financial procedures and finds it challenging to navigate through banking systems, opting for a lump-sum investment may not be the best choice. On the other hand, if they are financially responsible and can handle large sums wisely, trusting them with a lump sum might be suitable.

Technological Literacy: If your family is not well-versed in technology, there is a higher risk of falling victim to fraudulent schemes. You must guide them through the investment process and educate them about potential scams.

Internal Rate of Return: Consider the internal rate of return (IRR) while comparing lump-sum and staggered payouts. Although there is no significant difference in IRR between the two options, managing insurance allowances becomes more manageable with staggered instalments. Keep in mind that the usual IRR ranges from below 7% to as low as 4%.

Premium Payment Discipline: Staggered incremental options often require higher monthly premiums compared to standard lump-sum plans. If you foresee any challenges in paying premiums consistently or have concerns about potentially missing payments, opting for a lump-sum payout might be more convenient.

Conclusion

The decision between lump-sum and monthly payouts depends on various factors, including your family’s financial literacy, technological awareness, and overall financial goals. While staggered payouts ensure a steady income stream, a lump-sum payout can offer long-term returns if invested wisely. Additionally, a lump sum can provide quick access to funds in emergencies or for essential expenses.

To make an informed decision, it is crucial to engage with your chosen insurance provider and explore all available options. Seek input from peers or consult with a financial expert who understands your family’s unique needs.