I love interacting with my students. Their imagination has no bounds. I’ve grown up believing, ‘you can’t have the cake and eat it too’. But, my students think otherwise. They know how to eat the cake and have a calorie deficit too. One of such InnSightful conversations somehow ended up being about endowment plans. They said it’s like eating vegan meat – everybody wins. I’m still trying to wrap my head around that analogy, but let me decode an endowment plan for you.
An Endowment plan brings you the security of an insurance policy and the returns of an investment channel. You could choose from a bouquet of endowment plans which include Unit-linked Plan(ULIP), Guaranteed Plan, With-Profit Plan, Low-Cost Plan, and Non-Profit Plan.
Let’s take a microscopic look at what these plans endow upon you.
Experience the victory of hitting two birds with one stone: Here’s the good news! One way or another, there’s going to be money in the bank. Endowment plans usually have a higher tenure, say 20 to 30 years. So, in the event of your demise within this period, your family receives the sum assured, and if you survive the tenure, you’re returned the accumulated value of all the premiums plus additional bonuses earned through investments after deducting necessary fees. Make way for some passive income: You would have heard this term flashing across social media ever since the pandemic and your FoMo (fear of missing out) kicked into overdrive. That’s when a guaranteed income plan of 8% per annum was presented as an offer one wouldn’t refuse. Wrapped in a promise of tax free guaranteed passive income for life, you already signed up for it, didn’t you? For those who didn’t purchase one, I get your urge to stop reading further and buy one right away, but trust me you’d want to read what follows before giving into your impulses. Oh, the tax relief: Under Section 80C, the premiums you pay would be exempted up to Rs.1.5 lakhs per annum. Not only your premiums, but the income received (a lump sum or annuity payments) will also be tax exempted as long as your total annual premiums don’t exceed Rs. 5 lakhs per annum (for non-ULIP plans issued post April 1, 2023).
When something seems too good to be true, it most likely is. While an endowment plan seems like a lucrative insurance investment, you may want to decipher the asterisks that often go unnoticed.
Your annual premiums are equivalent to the flight tickets to your favourite international destination: We touched upon things being too good to be true, didn’t we? Say you consider an insurance plan with a sum assured of Rs.1 crore, the annual premium you pay for a term plan would probably be 10% of what you pay for an endowment plan which will set you back by a few lakhs if not more. You’ll wonder why. A term plan is strictly designed to cover the financial needs of your family if you’re no longer alive, the chances of which are minimal, up until a certain age. An endowment plan, on the other hand, is doing the same thing whether you’re alive or not. So, premiums for a term plan are cheaper because the chances of a payout is lesser compared to the certainty of payout for an endowment plan. If you’re interested in diving deeper into the mechanisms of these plans, I am just an email away. The benefits seem twofold, but so are the costs: A part of your premium pays for servicing your insurance and a part of it pays for managing your investment. Often, the investment management fee that you pay through an endowment plan is equivalent, if not more, than you’d pay to a traditional investment manager handling your mutual funds, instruments that often yield higher returns comparatively. You get returns, but not real ones: While the projected returns are estimated to be around 8%, the actual return known as internal rate of return is about 5.5 – 6% per annum. On average, India has seen inflation upwards of 6% per annum and the world is battling high inflation, so, your inflation-adjusted rate of return or real return is negligible. Now that I got you thinking about the vacation again, I am wondering if it was too soon to burst the bubble? Hold on though as my next blog has some InnSights that may be worth the wait! Surrendering the policy vs retaining it – Sophie’s choice: Many of my clients who consulted me for risk-profiling and retirement planning owned endowment plans or were about to. That’s the power of persuasion of endowment plans. When they had buyer’s remorse a few years later, they were quick to decide to surrender the policy. By surrendering, I mean you cancel the policy and accept whatever the accumulated amount is. That’s not always a good thing as there may be severe penalties involved due to your choice of going against what you signed up for. To put things in perspective, when I tried to surrender my plan for which I had paid 10 out of the 15 yearly premiums I agreed on, my surrender value after allowing for investment returns was 80% of my absolute premiums paid. Surrendering this policy would not have been the right choice! However, I did surrender two smaller annual premium paying policies as they would have matured 27 years later and the loss I made could be recouped by investing the money received on surrender via a mutual fund. Disclaimer: I’m not a mutual fund agent or promoting them in any form. Please review your risk profile before investing.
I’m hoping you would’ve understood the nitty-gritty of an endowment policy by now. There is a policy that works best for you but would do no good to a friend you might recommend it to. Your risk appetite, liquidity, demographics and many other factors are pivotal in determining the ideal policy for you. Financial and investment blogs have garnered a tedious reputation over the years. I’d try my best to build your intrigue and demystify the concepts you’ve been living with. Reach out to me if you’d like to review your Insurance, Risk and Retirement Planning portfolio. Together, let’s make informed decisions.