Term Insurance Plan vs LIC endowment policy : which is better? Myths and Facts You need to know

As every country in the world is looking at India as a “people rich, open market” for a business opportunity; it is obvious that, our FREE inboxes are full of advises to  make us rich and feel comfortable. So is the case with intrusion from foreign insurance companies. We will discuss some of the myths spread against LIC’s traditional policies and why they boast their term insurance plans.

Myth 1 : Returns from traditional LIC policy is less!

Many a times our lack of knowledge on economic matters make us prey to unforeseen  financial tragedies.  Let us discuss 3 of the most powerful financial terminologies

  1. Rule of 72
  2. Taxable Income
  3. Net Returns

Rule of 72

Ever wondered how to calculate years needed to double the investment at a given annual rate of interest ? We have a very handy formula called rule of 72.

Years required to double investment = 72 ÷ compound annual interest rate.

For eg. if the rate of interest is 8% for an investment scheme, and one is  investing 100 rupees, that scheme will return 200 rupees after 9 years!

Taxable Income

Taxable income is that income for which income tax is payable. Listed below are some of the common examples of taxable income.

  1. Salary
  2. Bonus
  3. Employee awards
  4. Income from part time jobs
  5. Interest received from investments
  6. Dividends from stocks ,shares etc.
  7. Annuity etc.

The point here is, what ever be the source of income, government has the right to collect income tax on that.

Net Returns

Think of a scenario like this. If one could invest 100 rupees @ 8% interest rate,  that scheme will fetch 200 rupees at the end of 9 years. For calculation easiness, let us take income tax rate as flat 30% (which will soon be the case). Government will levy 30 rupees from the additional 100 rupees we earned. So the actual growth we received after 9 years is just 70 rupees.

Like ways, the actual return on any investment, with a guaranteed level of growth, after paying income tax, is just 6% to 8% only.

So it is obvious that, Life Insurance Corporation (LIC) is never reluctant to pay good returns to policy holders. LIC returns 6% to 7% and for that one need not pay any further tax. The earnings are 100% TAX FREE under 10(10(D)) of Income Tax Act of 1961. This is over and above the 80(c) exemption government provides for the premium payment. But that is not the case for bank interest or other taxable incomes.

Myth 2 : buying Term Insurance plan is the right financial decision

Term Insurance by definition is risk transfer. It is an arrangement to protect the financial well being of the family in case of the unforeseen demise of the bread winner. A term insurance plan will trigger only in the death of the policy holder. Since the insurer need not return anything after the coverage tenure, these plans are relatively cheaper.

Common Features of Term Insurance Plans
Policy Period Minimum : 5 years

Maximum : 35 years

Minimum Sum Assured 1 lakh
Maximum Sum Assured No limit, based on the financial background of the policy holder
Premium Paying Term For the entire policy term
Premium Varies among insurers
Maturity Value On survival to the end of the policy term, nothing shall be payable to the policy holder.
Maximum Cover Ceasing Age 60 to 70 years
Grace Period for  due premium 15 to 30 days (maximum)
Tax Benefit Premium paid is exempted under 80(C)

Benefits of Term Insurance Policy

  • Benefit 1: From an income replacement perspective, term plan is helpful for the family to recover from the financial catastrophe arises due to the untimely death of an earning member.
  • Benefit 2: Relatively cheaper pricing compared to savings cum protection type of endowment plans.

Disadvantages of Term Insurance Policy

We can broadly classify the disadvantages as Technical difficulties and Psycho Economical disadvantages

Technical Difficulties

  1. Post grace period, if not paid, the policy is gone!
    Even if one had paid for 15 years, for a 20 years term plan, policy will stand cancelled. Whatever one had paid that far also is not refundable! Another option will be to start afresh. But then the  insurance company will treat it as a new application.  Thereby all the formalities one need to start from scratch. Bottleneck here is, the policy holder will not have the same health conditions or economic conditions now, as it was when he took the policy.
  2. Adhering to the terms and conditions set by an insurance company is a real challenge.
    Who has the courage to read, understand and adhere to the multi page contractual agreement many insurers will offer for their benefit.
  3. Chances are there, you may lose money!
    If any company is offering you a really cheap online term insurance policy with no medical requirements, beware!

Psycho Economical Disadvantages

  1. “Everything is Safe” feeling – This is a serious mistake one can ever make, because an insurer knows 110 ways to reject an early claim. Read more about claim rejections here.
  2. Lack of Saving Habit – this is the after effect of the first. On survival, a term insurance plan will not pay back anything. Hence by keeping the false positive that, “I’ve fulfilled my family duty”, one may lose the opportunity to save money in steady growing, secure funds. The result is the financial instability during old age.

LIC’s Savings and Protection Plans : A Clean Winner over Term Insurance Plans

Now take the case of a traditional LIC policy. It is having components of both savings and protection. Surely one ought to pay a higher premium. But for what?

Proof of Concept

Let us take the example of the New Endowment Plan (Table Number 814).

Criteria Value
Age 30 years
Policy Period 20 years
Sum Assured 5 lakhs
Annual Premium Rs. 24,309 (twenty four thousand three hundred and nine) approximately
Premium Paying Term 20 years
Total Premium Paid to LIC  24309/year x 20 years = 4,86,180 (Four Lakhs Eighty Six Thousand One Hundred and Eighty) rupees
Grace Period for due premium 2 years from the date of first undue premium
Tax Benefit Premium paid is exempted under 80(C) and Maturity exempted under 10(10(D))
    • Case 1 : Within  20 years, if the policy holder dies, his nominee will get rupees 5 lakhs as sum assured plus bonuses if any.
    • Case 2 : If death was due to an accident, and LIC’s Accident Benefit rider (DAB) is opted by the policy holder at the time of taking the policy, an additional sum of 5 lakhs will be paid. So total payout to nominee will be rupees 10 lakhs plus bonuses if any.
    • Case 3 : Policy holder survives. In this case a sum approximately equal to 955000/- (Nine Lakhs Fifty Five Thousand rupees) will be paid back to the policy holder by LIC. Moreover, this amount is 100% TAX FREE, legal, useful money. Some may claim that the policy holder receives 1% less if he survives. But the question is, what if the case was A or B above. That too in the very first year itself. Total return would have been 2000% to 4000%.

Be A Prudent Investor

Will anyone treat themselves, for an ailment, that needs medical attention, by simply following the instructions given by any website? Even if one can find all the medicines with their usage, side effects and dosage online? Answer is a big NO.

So situations are there, where one have to go by common sense, expertise, credibility, safety and security. The rule of thumb is, irrespective of the topic of search, one will end up with 50% positive and 50% negative results. That is quite normal. But one need to be smart enough pick the right option.

Nothing Comes for Free. LIC gives us loads of benefits such as sovereign guarantee, stability, tax savings for just 2%.

To sum up, just by believing on a company’s cheap term insurance policy and setting it as a milestone in our financial planning, we can bring our economic doomsday real closer.

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