This is an interesting story that highlights how financial products under the disguise of “Save Tax” tags are being mis-sold on a daily basis.
The other day, I met a dear friend of mine who had just taken an endowment policy. I asked her why did she take it and who recommended it.
Background of Story
Expectedly, it was her bank relationship manager (RM) who suggested this policy. And why did RM suggest this? As per RM, it offered the holy trinity of
- Good Cover
- Lesser charges than ULIP
- Yet, good returns with tax benefits
As a result, she had no qualms in taking the policy. We argued on the first two-point on why the same could be achieved in a better manner with plain vanilla term insurance and mutual funds.
Term insurance policies offer a much higher life cover at a very cheap premium. While the return on investment is much better if you invest in mutual funds rather than endowment policies.
This ultimately led us to check the third point. There were a beautiful looking and slightly confusing illustration which showed the 20-year schedule with guaranteed benefits.
The RM had said returns of around 8%. With the tax benefit of 80C, return goes to around 10%.
On checking the illustration we found that the returns actually came to around 7%. In contrast to the 8% promised over a long period, this was less by 1%. Hence, I thought I had won the argument. I was surprised when she replied, “it’s just 1% and anyway the icing on the cake is the tax benefit”.
Then it struck me. The tax saving thing was FARCE!! I told her you are being swindled by her RM, as your provident fund contribution and existing health insurance fill up the whole 1.5 lacs deduction quota available under the section 80C. The plan was useless.
She did not believe me and said would double-check!!
The next day she called and was raging with anger. She said you were right!! The next thing she had called her RM to inquire about the same. RM said, “he was under the impression that she did not have enough provident fund contribution and hence the recommendation”.
These type of misselling of financial products are quite rampant these day.
As I sympathized with her and told that surrendering this policy at a loss is the only good option.
Let’s ignore the misselling part for a while. We are going to compare the endowment policy itself with the other financial products options available to us. As I mentioned earlier, the death benefit is not even a fraction of what you can get with term insurance, that too with a very cheap premium.
Then ideally the return on investment (ROI) must be much better. Even if the ROI is less than stocks or mutual funds but it should at least beat inflation and fixed deposit (FD) returns.
Let’s deep dive into the endowment policy and compare it with the inflation and FD returns.
Typical Endowment Policy Details:
There are multiple plans available under this policy. We are taking a 10-year premium payment term plan where you need to pay a premium of Rs. 50000 for the first 10 years and from 11th year onwards, you start to receive a monthly (1% of GMB) or yearly (11.5% of GMB) guaranteed cash benefit.
Premium Amount – Rs 50000 Premium Payment Term – 10 years
Policy Duration – 20 years Sum Assured Amount – Rs 500000
Cash Benefit Mode – Yearly Age at Entry – 35 Years
Guaranteed Cash Benefit (GCB) – 11.5% of Guaranteed Maturity Benefit* (GMB)
*GMB is the fixed amount you receive at maturity of the policy
A – Total Guaranteed Cash Benefits (GCB): Rs 304474**
B – Guaranteed Maturity Benefit (GMB): Rs. 264760**
C – Vested Reversionary Bonuses: Rs. 251969** in best case scenario & Rs. 0 in the worst-case scenario
D – Terminal Bonuses: Rs. 195476** in the best case scenario & Rs. 71233** in the worst-case scenario
**These are approximate figures for a healthy male. They depend on multiple factors including future performance.
C benefit is not guaranteed but may be declared every financial year. D benefit depends on the policy. Please check with your RM if there are any terminal bonuses associated with the policy.
Maximum Benefits by Maturity after 20 years: A+B+C+D = Rs. 1016679 approx
Minimum Benefits at Maturity after 20 years: A+B+C+D = Rs. 640467 approx
Comparing endowment policy with 20 years inflation: When we invest our money with such guaranteed benefit policies and meagre death benefits, we would want it to beat the Inflation to the least. So that we do not lose the value of our hard-earned money. Look at the below chart for the inflation-adjusted value of your premiums in 20 years time.
You are losing 27% of your money’s value in the best case scenario and 55% of your money’s value on worst-case scenarios in 20 years time. How is this even possible? Your bank must be investing your money somewhere to beat the yearly inflation. But they are making money for themselves, not for you via such policies.
Let’s look at one more scenario as inflation rates can be unpredictable over time.
Comparing Endowment Policy with Fixed Deposit (FD) returns in 20 years:
FD returns are quite predictable over a long period of time. Even if the policy returns are less then inflation-adjusted returns, it should ideally beat FD return as no specialization is required in doing FD. It is not like mutual funds or stocks where banks have to put experts.
In this case, as well, you are losing 22% of your money’s value in the best case scenario and 50% of your money’s value on worst-case scenarios in 20 years’ time. Again, your bank must be investing your money somewhere to beat the FD returns to the least but they are cutting a huge pie for themselves and giving you almost nothing but taking from you as well.
These policies are designed to be a win-win strategy for banks only.
So when you see ads like these, evaluate them from every possible angle and compare them with the other financial products. You must do smart tax planning. There is a particular order in which you must opt these tax-saving instruments rather than randomly choosing any product.
Also under the new tax structure, a lot of things have changed for the upcoming financial year. Get a clear understanding of both the tax structures and choose the right one for yourself.