Debroop Roy, 26, was approached by a family friend, dubbed as an insurance agent, with a lucrative investment plan. Roy will have to invest ₹1.2 lakh every year for 12 years and from the 13th year he will get ₹1.3 lakh per year for the next 34 years. That’s not all. the ₹14.40 lakh paid in premiums in the first 12 years will be fully refunded in the last year of the investment term.
“The plan caught my attention because it promises a guaranteed annual income until the end of retirement and also pays back the full amount of the investment. But I approached a financial expert before committing because I know how pushed traditional insurance policies are during tax-saving season,” Roy said.
Roy was right to do so. The internal rate of return (IRR) of this traditional insurance policy is 6%. In an insurance policy, the IRR tells you the rate at which the money invested will grow to produce the guaranteed amount at maturity based on inflation.
Mint calculated the IRR of three different traditional life insurance plans – an endowment plan and two refund plans with and without premium refund options – and found that traditional insurance plans with policy durations of Ages 20 to 35 typically earn 6% (see chart). This is less than other comparable fixed income investment options of the Public Provident Fund (PPF) and the Sukanya Samriddhi scheme, which also enjoy triple taxation benefits such as life insurance products, which currently offer annual interest rates of 8.1% and 7.6%, respectively.
“Policies purchased 20-25 years ago mature to yield 6% to 7%. It should be noted that 20-22 years ago the 10-year G-sec yield was 12%, the 30 year G-sec yield was around 14% and AAA bond was 16-18% Meanwhile, if someone had invested in AAA bonds and reinvested after 5-10 years in G bond -sec at 10 years, the return on investment would have been compounded to at least 9%. If you compare that, traditional insurance plans are strictly no,” said Vijai Mantri, co-founder and chief strategy officer of investment, JRL Money.
The idea is not only to see what you earn on your investment, but also to draw attention to the glaring lack of insurance coverage these schemes offer. “Insurance’s primary appeal is protection and endowment plans fail to achieve that,” Mantri said.
Typically, financial planners suggest buying life insurance coverage for 10 to 12 times one’s annual income. This is quite affordable if you buy a pure risk term plan. For example, a 30-year-old woman has to pay approximately ₹11,000 premiums per year for a ₹1 crore life cover. In a traditional plan, on the other hand, affordable premiums provide woefully insufficient coverage.
“In an endowment plan, you can either pay an affordable premium or get enough coverage. If you want to buy life cover from ₹1 crore through an endowment plan, you will have to shell out ₹6,000,000 – ₹7 lakh a year on premium alone,” said Prableen Bajpai, founder of FinFix Research and Analytics.
The attraction factor
It’s no secret that traditional insurance plans are sold aggressively in the last quarter of every fiscal year, when taxpayers scramble to make last-minute, tax-saving investments. . The call is not only a tax relief on the premium, but also a tax-free maturity product.
“The proceeds at maturity, including premiums, received from life insurance policies are fully exempt from tax provided that the ratio of premium paid to sum assured does not exceed 10% during a For policies issued before April 1, 2012 and after April 1, 2003, it’s 20% of the sum insured,” said Sujit Bangar, founder of Taxbuddy.com.
Kartik Sankaran, founder of Fiscal Fitness, is of the opinion that tax breaks on life insurance policies prove to be more costly than paying taxes. “The product at maturity is tax-free and you get tax relief today, but you live with 20+ years of bad returns. Rather, the premium should be allocated in a mix of plan to term and equity-linked savings plan (ELSS) funds. Even after paying long-term capital gains (LTCG) on an ELSS fund 20 years later, you will have more net income.”
Insurance policies lack liquidity and flexibility and therefore are not the ideal tax saving tool under Section 80C. In comparison, the ELSS, PPF, and National Savings Certificate score higher in terms of flexibility because they have shorter lock-ins of 3 years, 15 years, and 5 years, respectively. Partial withdrawal on PPF is allowed after 5 years.
The idea of protection and savings in one plan along with guaranteed returns makes traditional plans still very attractive to many investors. “As long as the customer knows what they are buying it is fine but the problem is that sales practices are such that these plans are sold without properly explaining the long lock-in commitments and the premium has to be paid for a few years and not just the first year,” said an industry expert who did not wish to be named.
Policyholders, experts said, should ask about IRR, lock-in period and payment terms before buying a policy.