Here’s a great investment idea. Invest Rs 25,000 a month for 20 years and get nearly Rs 64,000 a month from the 21st year onwards for the next 16 years. The income will also keep increasing by 6-7% every year. The investment is eligible for tax deduction under Section 80C.
What’s more, the income received will be tax free and the buyer will also get insurance cover of almost Rs 80 lakh. Isn’t that a great way to retire in comfort without worrying about taxes? That’s what Sachin Khairnar also thought when he signed up for the Retire and Enjoy combination plan of 16 Jeevan Anand policies in 2012. “It sounded very attractive because I would get assured tax-free income as well as a life cover,” says the Pune-based professional.
Every year, thousands of buyers like Khairnar invest in traditional insurance plans, lured by the “triple benefits” of tax deduction at the time of investment, life cover during the policy term and tax-free income on maturity. But traditional insurance-cum-investment plans give abysmal returns.
ET Wealth looked under the hood of 10 such traditional plans and found that the average return was barely 4.8%. The returns have been calculated using the internal rate of return (IRR) method. “Ask your adviser to calculate the IRR on the excel sheet as different companies and plans can give very different returns. There may be plans out there which give only 2-3% returns,” says Sanjiv Bajaj, Managing Director, Bajaj Capital. If Khairnar’s 16 policies will earn 6.84% returns it is because some of them are very long-term plans and will continue till he is 70 years old. A typical 20-year plan will not yield more than 4.5-5% return.
Returns of traditional insurance plans will not beat inflation
Premiums and calculations are for a 30-year-old male non-smoker policyholder
Life cover too low
The insurance companies do not dispute ET Wealth’s calculations. However, they point out that these insurance plans also offer life cover to the buyer.
“No other investment product offers guarantee for a long tenure of up to 20-25 years, in addition to the risk cover,” says Manik Nangia, Marketing Director and Chief Digital Officer, Max Life Insurance. “Considering the additional benefits of income tax and life insurance, it makes for a very good proposition,” says Deepak Mittal, Managing Director & CEO, Edelweiss Tokio Life Insurance.
We agree: these plans also offer life insurance, which is a very critical component of financial planning. In fact, ET Wealth has always maintained that life insurance is the lynchpin because it safeguards all the goals even if something happens to the breadwinner. However, these traditional plans are not the best way to get insured because they offer insufficient cover.
A person earning Rs 70,000-80,000 a month needs an insurance cover of roughly Rs 1 crore. A term insurance cover of Rs 1 crore will cost a 30-year-old male about Rs 12,000-15,000 a year. But the same cover from a traditional insurance plan will require an annual premium of at least Rs 10 lakh. Going for such a plan would mean putting all other goals and expenses on the backburner.
Poor returns, low cover
Traditional plans fall between the two stools because they offer poor returns and insufficient cover
Obsession to save tax
Insurance cover is the last thing on the mind of the average buyer of traditional insurance plans. His primary objective is the tax deduction under Section 80C. “People buy traditional policies for tax savings, safety of capital, assured returns and life insurance cover, in that order,” says Manoj Nagpal, CEO of Outlook Asia Capital.
Insurance companies and their agents feed on this obsession to save tax. Almost 70% of the total business of life insurance companies is transacted in the last three months of the financial year when millions of taxpayers are trying to invest under Sec 80C. But life insurance is not the best way to save tax either. Other instruments can achieve that objective in a much better way.
For risk-averse investors, there are 5-year bank fixed deposits and small savings schemes such as NSCs and PPF. The interest from fixed deposits and NSCs is taxable so the real rate of return for someone in the 30% bracket comes to 4.9% in case of bank FDs and 5.6% in case of NSCs. But the PPF offers tax-free returns of 8%. Those with daughters below 10 year can even opt for the Sukanya Samriddhi Yojana that offers 8.5% tax free.
For investors willing to take a small risk, the NPS can be a good option. It offers market-linked returns, though the investment gets locked till retirement and only 40% of the corpus is tax free. ELSS funds are also tax-free and have the potential to give significantly higher returns, though the risk out there is also higher. Insurance companies argue that it is unfair to compare life insurance policies with other instruments on the basis of returns. “One should not consider the returns alone. These plans also provide life insurance cover and the cost of the cover should be factored in,” says Sujoy Manna, Vice-President, Products, HDFC Life. That’s a fair point.
We compared the returns of an endowment plan with those of a term plan combined with the PPF and ELSS funds. Assuming a return of 8% for the PPF and 12% for the ELSS fund, both combinations would give better returns and higher insurance cover to the buyer.
Selling like hot cakes
Despite the poor returns and low insurance cover, traditional plans still sell like hot cakes in the last three months of the financial year. According to one estimate, traditional insurance plans account for nearly 70% of the total premium collected by the life insurance industry. “The life insurance market is largely focused on traditional plans,” says Alok Bhatnagar, Co-Founder and CEO, EasyPolicy.
There’s a good reason for this skew. Ulip charges were capped in 2010 and term plans don’t have high premiums. So, agents like to push traditional policies that offer them higher commissions. “Traditional plans get pushed more due to higher remuneration component to the sales channel,” says Amol Joshi, Founder of PlanRupee Investment Services.
The other reason is that buyers don’t understand the time value of money. They don’t realise that the huge maturity amount being projected may mean little after 25-30 years. “The main reason that traditional plans provide such low returns is because of their payout structure,” says personal finance blogger and author M. Pattabiraman. “Payouts are not given as lump sum benefit but are spread across the years, which severely reduces the net return,” he adds. Suresh Sadagopan, Founder, Ladder7 Financial Advisories points out that investors also get taken in by terms like “assured returns” and “guaranteed income”, without realising that getting that sum after several years may be a losing proposition.
Insurance is also not the best tax saver
Life insurance plans give the lowest returns among all Sec 80C investment options
Where the plans score
They might have a lot of shortcomings, but traditional insurance plans have one redeeming feature. They enforce a saving habit in the policyholder. Prodded by the agent, coaxed by a sense of responsibility towards their families and afraid of losing money due to lapsation, few policyholders miss the insurance premium.
It is not rare to see a policy mature after 25-30 years of regular premium payment. Few mutual funds can boast such a loyal following. AMFI data shows that nearly 46% of investments by small investors in equity funds are redeemed within two years. Investors tend to stop SIPs after 1-2 years, and even redeem investments meant for the long term.
Traditional insurance policies do not allow investors to dip into the corpus before maturity, though the policyholder can take loans against them, stop paying the premium or even end the plan prematurely. They enforce longterm saving discipline, although buyers pay a heavy price for it.
Yogita Khatri Economics Times