Let’s start with this great investment idea where you have to invest Rs. 25,000 monthly for the next 20 years and from the 21st year onwards, you’ll get Rs. 64,000 per month for the coming 16 years. Apart from this, your income will be increasing at a rate of 6-7% annually and you will also get a tax exemption in this investment under section 80C. Not only this, your income after the 20th year is also going to be tax free and you’ll get an insurance cover of approximately Rs. 80 lakhs.
Traditional Life Insurance Plans
Doesn’t this whole idea sound appealing? Who wouldn’t want to invest in such a scheme? That’s what every single investor thinks when s/he hears about traditional life insurance plans. However, all that glitters is not gold. The abysmal returns offered by traditional plans and policies overshadow the lure of ‘triple benefits’ (life cover during the policy term, tax deduction at the time of investment and tax-free income on maturity) provided by the plan.
As per a research performed by ET Wealth, it shows that the average return in every 10 traditional plans barely comes to a percentage of 4.8. These returns were calculated based on the IRR (internal rate of return) method. If your advisor calculates the IRR in an excel sheet, the returns can go to as low as 2-3%.
Low Risk Cover
Even though, insurance companies don’t dispute the calculations made by ET Wealth, they have point out the fact that life insurance plans do offer risk/life cover to the buyers. As per the insurance companies, there is no other investment tool that provides the buyers with a guarantee of 20-25 years and risk cover, in conjunction with the additional benefits of tax-savings & life insurance. ET Wealth don’t deny these points and has always considered life insurance plans as the foundation of all policies & plans as these plans single-handedly take care of all the goals of the investor if something happens to her/him. However, these plans still can’t be considered the best option because of their inability to provide sufficient cover.
Let’s try to illustrate it with an example. If a person has an income of Rs 70,000-80,000 monthly, s/he will need an insurance cover of approximately Rs 1 crore. In the case of a term insurance, Rs 1 crore cover will cost approx. Rs 12,000-15,000 annually for a 30 year-old individual. However, in a traditional life insurance plan scenario, the same cover will cost an annual premium of a minimum amount of Rs 10 lakhs. Opting for such traditional plans will clearly mean putting all your other goals & expenses on abeyance.
To have a better understanding of the reason that why life insurance plans doesn’t have capability of delivering good returns, we need to go in further detail. If you’ll look loosely, you will find out that most of the traditional plans offer hefty commissions to their agents which could go as high as 35 percent of your premium. It shows that for a premium of Rs 1 lakh, there will be a straight cut of Rs 35,000. And, even after this hefty deduction from your first premium, you could have to pay 2-4% as the trail commission from your second premium onwards. In this situation, there would be a very low amount of your actual money left to invest and hence, low returns on low investment.
As per the investment portfolio composed by IRDA, a minimum of 50 per cent of investable surplus of an insurance company is required to be invested in government securities. The cap set for the equity investments is that of 35%. If we take LIC for an example, it has invested about 4.75 lakh crores of its 21-lakh crore portfolio in the equities. Add up death claim pay-outs, administrative costs and the like and all you’ve got is considerably a very lower return amount from what you’d expected. The above stated arrangements are the major reason that short-term traditional plans aren’t able to offer an annual return of more than 4%.