Have a new born? Excited about what life has in store for your family, the fun times, the milestones and the first smile. Once the baby years are through, formal education starts and that’s when budgeting takes on an entirely fresh hue.
But you have been smart, on the insistence of a neighbour, uncle, aunt or parent you bought a ‘child plan’ offered by an insurance company. The lure being the money back that you get just at the right time, when you will have to pay for say higher education. The premiumThis is the amount you pay for keeping an insurance policy active. Usually paid in a lump sum at the start of the policy term or annually through the term, it includes all the charges and levies by the insurance... More seems high, so what, you think? The policy also has a death benefitThis includes the sum assured and any other pay outs like bonuses or accumulated fund value in case of a unit linked plan. This is what is ultimately paid out for the insurance claim made by the beneficiaries. More, if god forbid something happens to you. Plus, the real deal gets clinched when you hear that premiums get waived, while, the policy continues in the event of your untimely death.
All this is sounds like a great offer, and it is. But it comes at a greatly high price too!
The cost of such traditional money back and endowment policies make them completely unviable. Insurance companies also have the option of unit linked policies (ULIP) where returns are linked to the market, however, those too have some inbuilt inflexibilities which are not worth your while.
Always do the math
Let me use an example to explain the math to you.
Let’s say to log on to an online insurance aggregator website and look for an investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More plan for your child’s education. Your child’s age is assumed at 2 years and the monthly installment assumed is ₹5000. Maturity amount to be paid when your child turns 18. This means 16 years of investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More.
Typically, the search throws up ULIP kind of policies where you can choose how much risk you want to take. A low risk ULIP is one which does not invest in any equity assets and here results are simulated based on an assumed 8% per annum return.
First let’s calculated how much you spend. ₹5000 a month means ₹60000 annually. This translates to ₹9.6 lakhs in 16 years.
Now – with the assumed return of 8% per annum, ideally each policy should almost the same; most do show a pay out of around ₹15 lakh at maturity, the lowest figure is ₹14.2 lakh and the highest is ₹16.9 lakh. This is the investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More pool you will get after 16 years and an original investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More of ₹9.6 lakh. In absolute terms you have gained ₹7.3 lakhs if you take the policy that shows the highest return, in terms of the internal rate of return you are making roughly 6.5%.
There is a death benefitThis includes the sum assured and any other pay outs like bonuses or accumulated fund value in case of a unit linked plan. This is what is ultimately paid out for the insurance claim made by the beneficiaries. More, you say, which gets paid out if the parent dies. In the policy discussed above the death benefitThis includes the sum assured and any other pay outs like bonuses or accumulated fund value in case of a unit linked plan. This is what is ultimately paid out for the insurance claim made by the beneficiaries. More is ₹6,00,000. But premiums are waived on death and the pay-out will still come at maturity. Sure, but the additional cost to the company to provide you this benefit has already been included in the higher premiumThis is the amount you pay for keeping an insurance policy active. Usually paid in a lump sum at the start of the policy term or annually through the term, it includes all the charges and levies by the insurance... More you are paying.
Based on past performance
ULIPs also have a pure equity investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More fund, and here results are simulated based on past performance. The best-case scenario is from a policy that showcases a corpus of ₹32.2 lakhs (based on past performance pf 15.5% annualised return) at maturity and the worst case is ₹21.6 lakh (based on 11.5% annualised return as past performance). This does look tempting, however, there are two points to consider.
Firstly, in the event of your untimely death, your dependents will have a paltry, certain death benefitThis includes the sum assured and any other pay outs like bonuses or accumulated fund value in case of a unit linked plan. This is what is ultimately paid out for the insurance claim made by the beneficiaries. More of ₹6 lakh for death benefitThis includes the sum assured and any other pay outs like bonuses or accumulated fund value in case of a unit linked plan. This is what is ultimately paid out for the insurance claim made by the beneficiaries. More and secondly, if you want to switch your insurance provider you will have to undergo an entire insurance process all over again and your premiumThis is the amount you pay for keeping an insurance policy active. Usually paid in a lump sum at the start of the policy term or annually through the term, it includes all the charges and levies by the insurance... More is likely to be higher when you restart.
Pure Insurance – cost
Now let’s assume instead you get a term cover on your life where the death benefitThis includes the sum assured and any other pay outs like bonuses or accumulated fund value in case of a unit linked plan. This is what is ultimately paid out for the insurance claim made by the beneficiaries. More will go to your child in case of your untimely death. This is a pure insurance policyAn insurance policy gives you the right to reimbursement or payment from an insurance company for losses agreed up on in a defined contract. A life insurance policy for example, needs the insurance company to evaluate a claim on the... More and comes at a much lower cost. A salaried, 31-year-old female can get a life cover of ₹2 crore by paying ₹1,646 monthly and the premiumThis is the amount you pay for keeping an insurance policy active. Usually paid in a lump sum at the start of the policy term or annually through the term, it includes all the charges and levies by the insurance... More increases to ₹1,882 for men. Hence, in case of your untimely death your dependents will get a sum of ₹2 crore. And this is not an uncertain fund value, it’s a certain death benefitThis includes the sum assured and any other pay outs like bonuses or accumulated fund value in case of a unit linked plan. This is what is ultimately paid out for the insurance claim made by the beneficiaries. More amount that the policy covers you for. You really don’t have to bother about the premium waiverIn some types of insurance plans, the policy continues even after the person insured dies. However, the beneficiary does not need to pay any further premiums and this is called a premium waiver. More that the child plan offers, because this itself is a good enough amount.
Pure InvestmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More – benefit
Of course, the above is just an insurance, hence, you get nothing if you survive the term of the policy. Then, what about the child education fund? Use the money which you would have given for the child plan premiumThis is the amount you pay for keeping an insurance policy active. Usually paid in a lump sum at the start of the policy term or annually through the term, it includes all the charges and levies by the insurance... More to invest in a tax saving equity mutual fund. Let’s recap quickly, we had assumed a monthly premiumThis is the amount you pay for keeping an insurance policy active. Usually paid in a lump sum at the start of the policy term or annually through the term, it includes all the charges and levies by the insurance... More of ₹5000 for the child plan. This can be invested in a tax saving equity mutual fund – tax saving because, just like the child plan in insurance you get to use the 80C tax benefit. At an assumed rate of return of 12%, (traditionally, tax saving equity funds have delivered an average return of 15%-17% in a 15-16 years period), you will have a corpus of ₹29 lakh roughly. If we make the assumption 15% annualised return, then you are looking at a corpus of roughly ₹40 lakhs.
The reason the amount calculated at 15% is higher in case of an equity mutual fund (₹40 lakh) as compared to a ULIP for a similar return (₹33 lakh for 15.5% annualised return) is because insurance linked investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More plans will deduct mortality charges that eat into your investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More return. These are best avoided.
Hence, always keep insurance as pure term and use pure investments to get the most efficient returns.
USE OUR COMMENTS SECTION BELOW TO LET US KNOW IF THIS APPEALS TO YOUR COMMON SENSE.
Drawback
Unlike an insurance plan, the mutual fund redemption will be subject to a 10% long term capital gains tax. This however, is not a consideration enough to give up the higher returns, flexibility and transparency that mutual funds award you with.
What if you already have a child plan?
Should you continue to pay the premiums or consider them as a sunk cost? If you are close to the policy’s maturity then continue till the end as its not worth surrendering.
If it is a unit linked policy that you are using for this goal, then in the first five years you will not be able to surrender. Post that you have to do a cost benefit analysis. The calculation above on insurance plus investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More is one such example. Alternatively, you may not to move to a ULIP with another insurer who has a better performance track record (I still wouldn’t recommend ULIPs as investments).
For a traditional policy, it’s unlikely you will get any of the premiums back if you surrender in the first three years. After that you will get up to 50% from the fourth till the seventh year. Now if the tenure of the policy is 8-10 years, it doesn’t make sense to surrender in the seventh year. Remember, surrendering means you will not get all the ‘investment’ amount back. So, you will have to consider some part of it as sunk cost.
Unless the premiumThis is the amount you pay for keeping an insurance policy active. Usually paid in a lump sum at the start of the policy term or annually through the term, it includes all the charges and levies by the insurance... More payments have become too much of a burden, it’s not feasible to surrender the policy close to maturity.
Also, the process to surrender the policy can be cumbersome; you will have to visit the insurer’s office and there could be penalties involved. Do a cost benefit analysis with the alternative investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More option like mutual funds discussed above. Only if you are able to earn more after account for the lost capital and other charges on surrender should you go ahead.
USE THE COMMENTS SECTION TO LET US KNOW IF YOU ARE STUCK WITH AN UNSUITABLE INSURANCE POLICYAn insurance policy gives you the right to reimbursement or payment from an insurance company for losses agreed up on in a defined contract. A life insurance policy for example, needs the insurance company to evaluate a claim on the... More FOR YOUR CHILD’S EDUCATION GOAL.
Often repairing the damage becomes too costly. What is more suitable is to ask the right questions at the start and if you have already made the mistake of mixing insurance and investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More then try not to repeat this again.
Keep both separate, keep it clean. There are insurance plans (ULIPs) which claim better returns than mutual funds, now with a 10% long term capital gains tax on equity mutual funds, these ULIPs seem to be finding a lot more favour not only with investors but also with advisors. However, they are not flexible, remember there is a 5 year lock in, you only have the past performance to support your decision, they are not as transparent and liquid as mutual funds and switching your fund manager is not possible unless to take a new policy – which, will cost you more as it will have to be done at least after the 5 year lock in.
When it comes to your child’s education goal, it is your duty to ask more questions and demand truthful answers. Be smart with your investments, don’t fall for emotional marketing and don’t invest simply for tax benefits – remember ultimately it’s your child who has to benefit from this decision.