Term plans have been under the spotlight in the recent years and for good reason. Any financial planner's first choice would always be a term plan to address your insurance needs because of the low cost.
During the same time, unit linked insurance plans (Ulips) have gained the most, in terms of market share because they are being sold as insurance-cum-investment products.
Also, given that there are options where one can move their corpus from debt-oriented to equity-oriented schemes four times a year without any additional charges, there are many who feel that it is ideal for them to opt for such products. Of course, seldom you get to know about the high costs that are involved in such products.
Of course, in the comparison between Ulips and term plans, one tends to lose sight of old-fashioned products like endowment and money back policies.
If youngsters were to ask parents about the policies they had purchased for their insurance needs, the reply, most likely, is going to be either of the above two. However, endowment plans can be a good option for those who like to play it safe. Let's look at working of endowment policies and what they have to offer.
Endowment products are those that expect the policy holder to pay a premium for a specified tenure and the maturity proceeds is given out at the end of the term. The maturity proceeds typically include, the sum assured and bonuses that the policy holder earns over the years. Let's understand the workings.
Suppose a 35-year old were to purchase an endowment policy for 20 years. His yearly premium for a sum assured of Rs 1.05 lakh is Rs 5,278. A sum assured of Rs 1.05 lakh has been taken to take the advantage of high sum assured rebate of 2/000 sum assured (it means that Rs 2 per Rs 1,000 sum assured. And per lakh, it becomes Rs 200), which kicks in after Rs lakh sum assured. A simple reversionary bonus rate of 40/000 has been assumed throughout the term.
Finally, an additional bonus of 100/1000 sum assured has been assumed. The final payout after 20 years is Rs 199,500 after you pay the premium for 20 years. This works out to a tax free return of 6.25 per cent. And that's not all. There are other benefits as well.
The premiums qualify for Sec 80C benefit that will save tax at the rate of 30 per cent. (assuming you are in the 30 per cent income tax bracket and the insurance premiums are a part of your 80C declarations)
The effective savings are Rs1,583 a year, which otherwise would be paid as tax. Once this savings through premium kicks-in, the actual returns climb to 9.48 per cent, almost to the tune of a debt fund. Then, there is a life cover of Rs.1.05 lakh and can be used to get a loan after three years.
Yes, it is a rather long duration scheme and pins you down for tenure like 20 years. But it can be positive as there are forced savings. This works to the advantage of the policy owner. Such policies help in creating wealth to meet financial goals, many of which can be long-term.
Debt form an important part of portfolio allocation and endowment plans could be a viable option. Also, for a young person, this policy is recommended as the premium for are low and hence the returns higher.
Additionally, once started, it is difficult to stop because huge surrender charges. This implies that a person is most likely to see it through its course, which is ultimately beneficial for the policy holder.
Compared with the other fixed income product investing options like National Savings Certificates, Post-Office Term Deposits (5 yr) and bank fixed deposits (5 yr), the returns in endowment plans are higher, as the returns in the case of other three are taxable. Only Public Provident Fund beats the returns as the proceeds are tax free. Still, these plans give life cover, which is their main function - the returns are a valuable addition.
The writer is a certified financial planner.
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