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Monday, April 16, 2018

The good side of the endowment plans which can be used smartly

I would like to call myself a rational person who likes to be without bias and greed. Well with a bit too much of rationalistic approach, I found myself actually biased towards 'being rational.' I can call myself rationally biased towards my investment choices, aggressive allocation of equity on portfolio and staying away from debt heavy instrumemts, especially the fixed deposits for short term amd endowment plans for long term to be specific. Well, that fits well with my current age, but that is not the only way to look at long term investing. Endowment plans fits perfectly for a set of investors based on their risk profiles, investment objective, personal choice and priorities. Endowment plans stand out in long term debt investments. 

Though I like aggressive equity allocation for long term, with all humility I will accept that endowment as on today stands equal with the other long term debt products in various ways. Endowment plans have always have been a popular insurance cum savings product in India, credit goes to the hefty commission the insurance agents receives from the insurance companies for decades. My personal opinion have been rationally biased against it because of its lack of transparency on asset allocation, high agents commission, low coverage and low returns. The fact which bothered me the most is the "miss-selling". You may think, if I have so many rational points against the endowment plans, why I am even writing this post and what is my agenda? You will come to know. 

source - Wikipedia

With my first job, I joined the bandwagon of mutual fund investing, as the mutual funds investments were just picking up at fast pace, SIP was gradually getting introduced as a disciplined way of investing, superior tax-free return over long term was very attractive. And I hated the Endowment plans. I do have a active policy, I bought this one before I signed my first joining letter. Every time I paid the premium, I felt irritated about what a waste of my hard earned money until... until the 'D' day 2018-19 union budget struck hard on my equity dreams. Levying 10% tax on my artistically built equity portfolio on long term capital gains hit hard on my mind. It wasn't that the few other factors were not coaxing me to have a rational look at endowment plans and completely reject it, but the budget day nailed it. Budget not only introduced tax on long term capital gains, it also introduced 10% tax on dividends of equity and mutual funds. The equity dreams came crashing momentarily for many of us.

I recalled my father's advice, my boss's suggestion, inflation numbers and newly introduced Long-term-capital-gain-tax. In a whole it did push me to give a thought about taking a rational look at the cost and return analysis. 

While my view of equity being the best investment for long-term capital growth remains the same, endowment plans have made a special space for itself. Here is the list of things you get as benefits of endowment plans.

1. Life cover, as per IRDA regulations, insurance companies have to give a minimum 10 times life cover of annual premium, so at given point during the policy term you have a life cover, which is upto 20 times incase of endowment plans. For a 10 thousand yearly premium, you will be covered for about Rs. 2 lakh. The maturity value will be the accumulation of premium and interest earned from various instruments as the insurance company deplys the same to generate return. 

2. Income Tax benefit under section 80c. This product gives you tax benefit under income tax, the yearly premium can be calulated to reduce the income tax burden. 

2. Loan against insurance at a minimum interest rate - This is an interesting benefit which mutual funds, ULIPs or term insurance plan can't provide you. This instrument can be used as a collateral for an emergency loan if required, the loan amount and eligibility will depend on how long are you invested in the policy. Few people in my circle were immensely benefitted during medical and business emergencies. 

3. At the current interest rates, the return of 4-4.5% tax free is equivalent to the post tax fixed deposit returns. Also,there are no long term fixed deposit schemes over 10 years tenure in India. Over the years, India is moving towards low tax regime, which means in coming years the interest rate could go well below 5%. Endowment plans could give equivalent returns.

4. Tax-free return of accumulated corpus. This is a bonus. Given the recently launched LTCG, very few instrument like PPF and Life insurance.

This option is ideal for individuals above 45 years of age, as financial planners suggest reducing the equity exposure gradually and look for fixed income options. This option is also applicable for people in the highest tax bracket, as the post tax return on Fixed deposits are equivalent to the maturity value of a long-term endowment plans.  

This is a viable option for somebody who dont like equity investments, above 45 and looking at saving a corpus for retirement. Individuals with 30% tax bracket bracket can also consider the same as a long term FD with a provision of getting loan and tax exemption at maturity with life cover. However, One should keep a low exposure given its low return. For savvy investors, Term insurance and ULIP are good product which has a low cost structure and puts your money to good use maximising your profits.

To maximise the benefits, you should ask your insurance agent to pass on some cash benefit to you by paying first two premiums. This is a negotiable deal you can broke with the agent.

Kindly note that endowment plan should be bought only for long term  like 20 years and above. Endowment plans attract heavy penalty on missing due dates for premium, surrender pre-mature and may close the policy if policy-holders consecutively  misses premium payments. Also, it is an illiquid inveatment as one cannot withdraw the investments before its maturity or policy-holder's death. If one doesnt continue paying premium upto atleast 3 years, the investors will not get any return on the investments. Also, this may give very low or no inflation adjusted return given India's average inflation rate is about 5%.


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