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| There’s life beyond insurance |
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Rattan Chugh
ExpressMoney
Buying a two-in-one life insurance plan to invest money and save on taxes? Ensure it is not making you compromise on your other financial goals
Richa Sinha, 33, is a single, working woman. Since she has no dependents, she doesn’t need life insurance in the first place. Still, each year when she is looking to invest her surplus money, with the intention of saving tax and building wealth, she is sold a life insurance |
policy. The policies gave her the immediate tax rebate she sought and are accumulating wealth for her old age, but she is left with little cash to meet her mid-term financial goals. Says Richa: “I want to buy a house of my own as soon as I can afford to pay the EMI. I am tired of moving houses and negotiating rent every year.” |
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 Risk and returns
I meet hundreds of middle-income group people and analyse their portfolios. For most of them, insurance is synonymous with investment, which can partly be attributed to choices. Historically, bank deposits and insurance were the two main investment instruments available to small investors. Today, there is a range of investment products available to suit various needs, and insurance needn’t hold the pride of place in your investments or tax planning. |
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Life insurance, in its purest form, is a risk cover that offers financial protection to a policyholder’s dependents against the policyholder’s death. It helps them maintain their current lifestyle and pursue their life goals such as children’s education. Over time, though, insurance companies have blended the risk cover with the option of systematic investment, to the point where such two-in-one policies outsell pure risk plans.
Insurance-cum-investment plans investment offer convenience, but it comes at a cost and a reasonable payoff is subject to conditions. Typically, these plans are of long tenures and levy a steep penalty on premature surrender. Also, they may fetch you the tax exemption you are looking for, but they may not help you meet your financial objectives. |
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| The choice is yours |
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If all you want is insurance, buy a ‘term plan’. Term plans are the purest form of insurance, where the nominee receives the sum assured if the policyholder dies during the term. The premium on term plans is low. For instance, Richa, at 33, can get term insurance of Rs 15 lakh for a premium of around Rs 4,300 a year. But rarely would an insurance agent suggest this plan to you. Reason: their commission is a percentage of the premium, and term insurance premiums are the lowest among all life insurance plans.
The common argument agents give against term plans is that your premiums don’t earn any returns -- if you outlive the tenure of the policy, you don’t get any money back. And as a follow-up, they instead suggest endowment plans or unit-linked insurance plans (Ulips).
In endowment plans, part of the premium goes towards the mortality charges and the balance is invested. Here, if the policyholder dies during the policy tenure, the nominee gets the sum assured, along with the return on investment; if the policyholder survives the tenure, he still get back the sum assured and returns. Although the idea of survival benefit sounds attractive, the premium on endowment plans is much higher than term plans. Because of the steep premium, one sometimes ends up buying lower life cover than required. Also, the returns from endowment plans are low, as a conservative investment style is adopted.
Ulips get around the issue of lower returns by giving the policyholder the option to choose the investment plan based on their investment objectives. These plans work as mutual funds with options to allocate investments across debt and equity. Also, one has the flexibility to change the asset allocation during the tenure of the plan. Ulips look compelling, but even they are expensive. Typically, insurers take away 30 per cent of the premium as administration charges for the first two years, which leaves a smaller amount for investment. When compared with mutual funds, it typically takes Ulips 8-10 years before they can recover from these steep upfront charges, assuming the return on investment being identical in both cases.
Richa pays a premium of Rs 38,500 per annum for her endowment plans, for which, she gets a life cover of around Rs 9 lakh. If she took the same Rs 9 lakh cover through a term plan for the next 20 years, her annual premium will be around Rs 2,600 (subject to clearing medical examination). If she invested the balance Rs 35,900 for the next 20 years, she can build a kitty of Rs 22 lakh assuming an annualised return of 10 per cent or Rs 42 lakh on 15 per cent. Alternatively, she can use the balance along with her monthly rent of Rs 13,000 to afford an EMI for a home loan of 15 lakh. |
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Endowment plans and Ulips offer cover, but they are of long tenures and levy a steep penalty on early surrender. |
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