“JFM”, as the last three months of the fiscal are so fondly referred to at the offices of Life Insurance agents, is halfway through. Much to their delight, this is also the time of the year when even smart investors display an unusually high degree of cognitive dissonance by knowingly locking away long term moneys into low yielding financial instruments that solve no real problem.
An Ameriprise White Paper published four years back unsurprisingly discovered that most Indians tend to “buy the right product, but for the wrong reasons”. A classic case in point is the ungainly habit of piling up policies in the name of maxing out one’s Section 80(c) limit that allows for a deduction of Rs 1.5 lakh from one’s annual income.
Insurance is a critical Financial Planning tool – perhaps even the most important one. After all, even one unforeseen risk can topple even the best laid Financial Plan. Unfortunately, they make for a lousy choice when it comes to saving taxes – particularly the “traditional” variety (non-ULIP’s) that make up the lion’s share of overall premiums mobilized in our country (Rs 3.26 lakh crore in the last fiscal).
Traditional Insurance plan premiums attract a service tax rate of 3.75 per cent for the first year’s premium and 1.88 per cent for the subsequent years’ premiums. Factoring in the tax rate, most traditional plans provide annualized returns of just 4-6 per cent - after locking in your money for anything from 10 to 25 years. Talk about “much ado for nothing!”
If you save Rs. 1.5 lakhs in a traditional policy, you’ll also receive a death benefit ranging from 15 to 20 lakh. However, this death benefit can usually be replicated by taking up a simple, pure risk term insurance plan which will (depending upon your age and other factors) typically cost you just Rs 1,500 to Rs. 3,000 per annum.
From a long-term wealth creation standpoint, ELSS (Equity Linked Savings Schemes) Mutual Funds represent a much superior tax saving instrument instrument. If you’re concerned about sacrificing the associated death benefit, simply combine the ELSS with a simple term insurance plan. Do note that ELSS funds, being market linked, are high risk instruments.
If you’re extremely risk averse and are worried about the volatility associated with equity markets, you could combine a term insurance plan with a PPF investment to achieve a better result, with equivalently low risk. PPF returns currently stand at 8 per cent per annum. Even spending Rs 2,000 per annum to achieve a death benefit of say Rs. 20 lakh, and investing the remaining Rs 148,000 into a PPF account, will yield better returns over the long term.
Traditional policies also have punishing surrender clauses built into them. Only after a few years does the policy start providing any liquidity whatsoever; at any given point of time in the first half of the policy term, you’re likely to receive between 20 per cent and 30 per cent of the saved amount if you choose to surrender the policy. Once you’re in, you’re in for good!
It’s an uncomfortable truth that the Advisory business in India is rife with conflicted recommendations. What is good for the customer often fetches no commissions for intermediaries, and are hence not ‘recommended’ by them. Traditional policies, on the other hand, earn a neat packet of money for agents – anything from 25-35 per cent of the amount invested by you. ELSS Funds usually earn intermediaries less than 1/10th of that amount, and PPF mobilisations, even lesser. In such an environment, “advice” is bound to be colored.
