“Never buy Endowment Policies or Money Back Policies – they have the worst returns.”
“Never mix Insurance and Investment.”
“Don’t buy any Life Insurance except Term Insurance.”
These are opinions that you may have heard or read at some time. And these are based on logical facts, there is nothing wrong about them. But all this is not necessarily true for everyone, every time. Here’s how and why.
How do Endowment policies and Money-Back policies work
- Tax-free returns of about 5-6 % since premium is invested in Govt. bonds with sovereign guarantee.
- For the same reason, they are also extremely safe and there is no chance of loss of capital.
- Bonuses are accumulated and are paid on death or when the policy matures, whichever is earlier.
- These policies also come with an element of Life Insurance which is typically 10 times the total annual premium.
- A typical premium payment period is 15-20 years. A long period, really.
- If you miss paying a premium the policy lapses and you don’t get any further benefits.
- To exit from the policy for whatever reason, you can surrender it, but you get lesser than what you have paid as premium, i.e. negative returns.
- Some endowment policies offer limited liquidity through a loan, which comes at an interest rate and needs to be ‘paid back into the policy account’.
The Case for Endowment Policies for achieving Long Term Goals
< For everything you read next, remember this phrase “for achieving long term goals”. And read with an open mind to understand this perspective.
Let me use an example here to make things clear.
Pradeep is a conservative 25-year old export manager working in Noida, NCR. He is a graduate in commerce from Jaipur, earns about Rs. 4 lakhs per annum and just got married a few months back. His wife manages the housework. Since he has started working only 2 years back, he has limited savings as most of it was spent on himself. He has dreams of raising a family, providing for the family, meeting the children’s education and marriage expenses and also saving enough money for his retired life. He rides a Honda Splendor to work, but wants to buy a Maruti Alto in a few years time. He spends a substantial amount of money as rental income and so is contemplating buying a small house through a loan.
A friend of his, who is a life insurance agent approaches him, asks him some questions and then recommends that Pradeep should buy an endowment policy. Pradeep is concerned about returns, the high surrender charges and poor liquidity of the policy. To substantiate, these are the reasons the agent provides.
“Wealth Creation for the long term is all about Investment Discipline.”
There are several investment options available including FD, RD, Bonds, etc. But they lack a very important feature – enforced discipline. You may invest in an FD this year, but in the next year you may have expense pressure if a child is born in the family and end up not investing at all that year. That’s an opportunity lost for ever. Endowment policies force you to keep aside a certain amount of money every year (since the policy will lapse otherwise and all earlier premiums can be lost) whatever be your expense pressures. You may even have to reduce some frivolous expenses, which is a good thing because you end up using your money better and not compromising on your long term goals.
“High Surrender charges are a deterrent for stopping investment and encourage regular investing.”
If you ever think of stopping the policy and redeeming it, remember that surrendering endowment policies means losing some part of the premiums that you have already paid. So the high surrender charges will actually push you towards meeting your long-term goals.
“Poor liquidity is a good thing – it ensures you use the money efficiently and for the goal it was meant.“
In case you have a sudden need for money, endowment policies do offer a loan facility. But it is limited to a certain portion of the premiums that you have paid, and you need to pay back into the account to continue the policy. So this limited liquidity ensures that the policy continues and that your long-term goals are not compromised.
The agent then goes on to show Pradeep how endowment policies scores over other financial instruments in Pradeep’s case. Shown below is the table he used.
Click anywhere on the table below to see it full screen
Conclusion : Goal-based savings can be truly guaranteed only by Endowment Policies.
The agent then gives him the comfort of a recent change by IRDA on endowment plans, listed below.
Changes in Endowment Policies from Jan 1, 2014
- Surrender value of endowment policies has been increased, so losses on surrender, just in case, are minimal
- Death benefit for endowment policies is now at least 10 times the annual premium, giving you better protection in case of death
- Commissions have been reduced, making the endowment policies more efficient, which means that returns will improve.
Pradeep is now fully convinced and decides to go for the endowment plan.
Some of us are very disciplined with our investment behavior and adhere to Warren Buffet’s famous quote on saving : “Don’t save what is left after spending; spend what is left after saving.” You should go ahead and make your choice with products like PPF, FD, RD, etc. If you are okay with taking a little risk, MF and ULIPs are great instruments for wealth creation in the long term. But beware of the liquidity option!
For the large majority which is unfortunately less disciplined, Endowment Policies will continue to be a great option. Slightly lesser returns maybe, but guaranteed achievement of your goals.