So you been wondering what is the best plan for you, and you go through a lot of articles on the internet searching for a good plan. You find the advantages and disadvantages of each and you finally buy the best suitable one for you.
Wait..!! This never happens. Here's how it goes in our country.
You get a random call from someone, or someone approaches you personally and somehow convinces you to buy a good plan by telling you all the benefits of the plan.
Bingo!! This exactly is the first and a very serious problem you have already made. If you have not yet made, congratulations! You have already saved yourself a lot of money. I will show you how!
The plans that are shown to us, and the plans that we first look for - the insurance plans that give us returns.
Why do we like these plans that give us good returns?
Because... who likes to spend money and get nothing in return?
Why do agents advertise these?
Because... those are the ones that give them commission. Imagine a commission for a premium of Rs 50,000 and that on a premium of Rs 5000.
Why are they wrong? Isn't it good that we actually are getting returns and also an insurance cover, all together?
Well, let us check it out from the below 2 calculations. First, we will calculate a single plan with both returns and insurance. Second, we will calculate it for 2 different plans - first one with only insurance, and the second one with only returns. The catch here being, let's calculate it such that in both cases, we spend the same premium amount per year.
I will consider this plan I had taken at the age of 24. Note that these are the details of an actual plan (the policy and the company details are held back, however you may do the similar calculations for your policy in case you are taking one). Details of the plan are as under:
Annual Premium: Rs 50,000, Premium paying term: 16 years
Death Benefit: Rs 5,72,200
The plan was a market based plans, and the below figures are taken from the illustration of 10% increase in market value. Note that this is risk based, so the increase can be 6%, or 15%, etc. But usually these plans grow at the rate of 10% (you can check the history)
Returns (considering every premium is paid on time, and the policy matures with the insured surviving):
On completion of 4th year: Rs 1,14,444
On completion of 7th year: Rs 1,14,444
On completion of 10th year: Rs 1,14,444
On completion of 13th year: Rs 1,14,444
On maturity (completion of 16th year): Rs 4,89,800
So in a nutshell, you pay Rs 50,000 for 16 years (that is a total of Rs 8,00,000) and the returns you get in total is Rs 9,47,560. Additional to this, your life is covered with an insurance, whose sum assured is Rs 5,72,200.
Looks like a good deal... unless you have a look at the below calculations
A term plan is available for a death benefit of at least Rs 10 Lakhs. The annual premium for such a plan at this age is approximately Rs 4,000.
So in our case, we will have 2 plans, a term plan with an annual premium of Rs 4,000 and we will invest the rest of the amount, that is Rs 46,000 in Fixed Deposits. In such a case, the total amount we pay still remains the same, i.e. Rs 50,000 per year.
Also, we already know, that we are in a better shape for insurance as we are now getting a life cover of Rs 10 Lakhs, as compared to a cover of less than Rs 6 lakhs in the earlier combined policy.
Let us now calculate what are the returns we get in 16 years time considering we pay all premiums on time. Also, since we also get returns of Rs 1,14,444 in mid term, we will also make sure we get those in our case as well.
Year 1: We invest Rs 46,000
Year 2: We invest another Rs 46,000
Year 3: We invest another Rs 46,000
Year 4: We invest another Rs 46,000, and at the end of year 4, we get returns of Rs 1,14,444.
So by the end of year 4, we have invested Rs 46,000 (From 1st year) for 4 years
we have invested Rs 46,000 (From 2nd year) for 3 years
we have invested Rs 46,000 (From 3rd year) for 2 years
and we have invested Rs 46,000 (From 4th year) for 1 year
The amount we have made from this money (at the rate of interest of 6.5) is:
First year investment: Rs 59,535
Second year investment: Rs 55,817
Third year investment: Rs 52,332
Fourth year investment: Rs 49,064
Total Amount you saved: Rs 2,16,748
I know, these values are unbelivable, you may consult your bank or just verify this from any online FD calculators. This is the power of compounding.
Now, you take out Rs 1,14,000 as this is what you got in return in your combined plan. You reinvest the rest of the amount, i.e. Rs 1,02,304 is reinvested.
Similarly, you simulate to calculate for the rest of the years.I will go a little quick with the calculations now.
At the end of Year 7:
Year 5: Invested 46,000 for 3 years, made Rs 55,817
Year 6: Invested 46,000 for 2 years, made Rs 52,332
Year 7: Invested 46,000 for 1 year, made Rs 49,064
and we had reinvested Rs 1,02,304 for 3 years, which is Rs 1,24,136
Total we have invested now is Rs 2,59,517
We again withdraw Rs 1,14,000, now we are left with invested amount of Rs 1,45,073.
Now, at the end of Year 10:
Year 8: Invested 46,000 for 3 years, made Rs 55,817
Year 9: Invested 46,000 for 2 years, made Rs 52,332
Year 10: Invested 46,000 for 1 year, made Rs 49,064
And Rs 1,45,073 invested for 3 years, is now Rs 1,76,033
Total now with us invested is Rs 3,33,246
We again withdraw Rs 1,14,444 and are now left with Rs 2,19,246.
Now, at the end of Year 13:
Year 11: Invested 46,000 for 3 years, made Rs 55,817
Year 12: Invested 46,000 for 2 years, made Rs 52,332
Year 13: Invested 46,000 for 1 year, made Rs 49,064
And Rs 2,19,246 invested for 3 years, is now Rs 2,66,035
Total now with us invested is Rs 4,23,248
We again withdraw Rs 1,14,444 and are now left with Rs 3,08,804.
Finally, at the end of Year 16:
Year 14: Invested 46,000 for 3 years, made Rs 55,817
Year 15: Invested 46,000 for 2 years, made Rs 52,332
Year 16: Invested 46,000 for 1 year, made Rs 49,064
And Rs 3,08,804 invested for 3 years, is now Rs 3,74,706
Total now with us invested is Rs 5,31,919 at the end of the term. We can withdraw all of this amount
Now that we have compared both the plans and actually calculated the values, you would easily know why I said that it is better to have a term plan and an investment plan, rather than just have a combined insurance plan that also gives you returns like an investment plan.
In the combined plan, we paid 50,000 annually, got Rs 1,14,444 at the end of years 4, 7, 10 and 13. We also got a maturity benefit of Rs 4,89,000 and a life cover of Rs 5,72,200.
In the second plan, where we split it into 2 plans, we paid a total of 50,000 annually same as the above, also got Rs 1,14,444 at the end of years 4, 7, 10 and 13. However, we got a maturity benefit of Rs 5,31,919 and a life cover of Rs 10,00,000, both of which are better than the previous plans.
Also, it is worth noting, that in the earlier plan, we had considered market rise of 10%, while in our 2nd split plans, we considered a rise of 6.5%. Yet, the returns that we got at 6.5% is more than those we got at 10%. Why does this happen?
The insurance agents will always tell you that you never get these returns in Fixed Deposits as the max rate you might get is 7 or 8 percent. However what they do not tell you is the detailed information.
I have explained it in a different post. find the link below.
Also note that we only considered the Fixed deposits for simplicity of calculation. You are free to invest the money into any scheme of your choice, in market shares, bonds, etc, as long as you can liquidify them at the intervals mentioned.
There are additional benefits of having a split plan. For example, you can always continue your life cover with only an annual payment of Rs 4,000. You may or may not invest into your investment plan if you do not have the funds. Moreover, if you need money in an emergency, it is right there for you without breaking your insurance cover, something you will never get in the combined plan.