Spend, Save and Invest Smartly

Endowment Plan or Term Life Plan

You have learnt in the previous newsletter how an endowment life policy works. You will now learn whether it is better to take a term insurance policy or an endowment life insurance policy.

What’s an endowment life policy?

It’s simple : Insurance + Savings
You pay a premium and insure your life for a sum of money (sum assured).You get bonuses until the time this policy matures. (Maturity period) On maturity you get :

Sum assured + Bonus.

What is a term life insurance policy?

A term life insurance policy is a pure insurance policy with no survival benefits. There is no savings benefit in a term insurance policy. The premiums charged are much lesser in a term life insurance policy as there is no savings benefit.

What are the returns you get in an endowment life policy?

You are 35 years and don’t know which life insurance policy to buy…Your life insurance agent suggests an endowment life policy. You take an endowment life policy paying an annual premium of INR 50,000 for a sum assured of INR 12.5 Lakhs. This policy matures after 25 years. You pay premiums till the policy matures.
Premium = INR 50,000
Sum assured =INR 12,50,000

He says Sir… this policy gives you a bonus every year till the maturity of the policy. You will get a bonus for 25 years.
You get a bonus of 5% of the sum assured :
= (5% of 12,50,000) = INR 62,500.
Your life insurance agent tells you :
You are paying a premium of INR 50,000 and getting a bonus of INR 62,500.Your life is insured free of cost.

What your life insurance agent doesn’t tell you :
The bonus is not paid to you each year but accumulates and is paid to you only on the maturity of the policy. (After 25 years).
There is no compounding of bonus.

The bonus of INR 62,500 accumulates each year and after 25 years it becomes INR 15,62,500.
If you survive for 25 years of the policy you get the Sum assured + bonus.
This is INR 12,50,000 + INR 15,62,500 = INR 28,12,500.
You have paid the premium of INR 50,000 per year for 25 years which comes to INR 12,50,000.

You get INR 28,12,500 from the endowment life policy after 25 years (On maturity)
Your returns from an endowment life policy are around 5.78%.
Endowment life policy

Table showing premium charged annually vs. Sum assured

Annual premium (INR) Term of the policy (Years) Sum assured (INR) Time you pay premiums (Years)
50,000-1,50,000 20 -25 10,00,000-15,00,000 10
2,00,000 - 7,00,000 25 25,00,000 -50,00,000 12
8,00,000-10,00,000 25 1,00,00,000 12

Endowment plan vs term life plan

Why is a term insurance policy better than an endowment life policy?

Term Life Policy

Table showing premium charged annually vs. Sum assured

Annual premium (INR) Term of the policy(Years) Sum assured(INR)
3000-4000 25 25,00,000
5000-7000 25 50,00,000
8000-12000 25 1,00,00,000

You must never mix insurance and savings. Take a life insurance policy which will provide for your family in your absence.

You need to take this policy across your working years till retirement.If you are 35 years and plan to retire at 60 years you take the term insurance policy for a period of 25 years.
You need to take term life insurance for at least 10-15 times your annual salary/income.

You take a term life insurance policy and invest the savings in premium (difference in premium of endowment plan vs term life plan) in a good investment.
If you are risk averse you can invest this saving in a fixed deposit .A fixed deposit gives you a return of (8-9%) per year. This is definitely more than an endowment life policy which gives you a return of only 5-6% on your investment.

If you like taking risks you can invest this saving in premium in equity mutual funds. These give you higher returns but at a higher risk. The returns could be 10-12% over time. You could also suffer a heavy loss if the stock markets crash. This makes an investment in equity risky.

What are the charges you pay in an endowment life policy?

The Insurer pays a commission of 30% or more to the life insurance agent to sell endowment life policies. The commissions are paid out of the premiums you pay for the first year of the policy.

This makes an endowment plan very costly when compared to a term life insurance policy.

What do you learn from this article?

You take a term life insurance policy instead of an endowment life policy and save on your premiums.
Term life insurance gives you higher insurance for lesser premium than an endowment life policy.

You invest the difference in premium in either (fixed deposit or equity mutual funds) depending on your risk appetite.

You get higher returns than an endowment life policy.

Insurance
Term Insurance