Rs 144 trillion. This is the size of India’s favourite financial savings instrument– bank fixed deposits. Rs 30 trillion. This is the next favourite instrument. Can you guess what is it? This is the size of savings plans of life insurance companies. This is twice the size of debt mutual funds in India and is 50% higher than combined sum held as current and savings deposits with banks.
A typical insurance savings product is pitched like this (LIC Bima Jyoti): Invest Rs 10,000 every month for 15 years. Get Rs 30 lacs at the end of 20 years. Get tax benefit under section 80C. Redemption proceeds are tax free as well.
What is not expressly told is that this will give a return of just 6.6% p.a. after GST and income tax benefits (assuming 30% tax bracket). And that there is a lock-in period of 5 years. Failure to pay premium in any of the first five years, not only will lead to loss of tax benefit but also attract surrender charges. Sadly, around 50% of people close their policies before 5 years and their net returns are much lower.
For such a long duration commitment there are better alternatives. A PPF that comes with similar benefits and 15 year term returns 7.1%. In fact, an ELSS (equity mutual funds that are eligible for section 80C benefits), which has just 3 year lock-in can return even higher. In last 20 years it has returned over 12% p.a. after tax. For death benefits a pure term insurance plan is much better. A Rs 1 crore cover can be obtained at an annual premium of around Rs 20,000.
It is extremely fascinating how the confluence of (a) high commissions, (b) tax benefits and (c) human fallacies have created such a colossal but nearly useless product.
- Life insurance savings products pay around 30% commissions to agents on first year premium and upto 15% from second year onwards. An agent will prefer selling these over a mutual fund that earns him just 1% for same investment garnered. That’s why your favourite finfluencer has started peddling these products in their “educational” Youtube channels. And that’s why your bank RM or distant relative talks so sweetly to you while suggesting investment options.
- Life insurance products were given tax benefit so that more and more people secure financial safety of their dependents. The tax benefits were created envisaging pure term policies that only pay death benefit. However insurance companies have misused this benefit for creating FD like products.
- Lastly, investors drop their guards as soon as they hear “guaranteed returns” and “tax benefits”. Many are not able to calculate the internal rate of return (IRR) embedded in these products. Finally, they rush to buy these products in March, just before the end of financial year without proper evaluation.
Best exit action for those stuck with such products, is to hold them till the lock in period of 5 years and then surrender the policies. This will help retain the tax benefit on redemption and minimise surrender charges.