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EPF, VPF, PPF and NPS are some of the better alternatives to guaranteed return policies by insurers
EPF, VPF, PPF and NPS are some of the better alternatives to guaranteed return policies by insurers

Insurers’ assured return plans are appealing but lack liquidity

  • Before buying this policy, calculate actual returns that you may get and set aside funds for future needs
  • EPF, VPF, PPF and NPS are some of the better alternatives to guaranteed return policies by insurers

Many investors are looking at guaranteed return plans from life insurers as an alternative to bank fixed deposits (FD). Insurers offer tax-free guaranteed returns for the long term if investors stay until the policy matures.

“We have seen higher demand for these plans on our platform, especially from those in the 20% tax bracket or higher. They are finding returns from these policies attractive as rates on bank FDs for a term of five years or higher are in the 5.4-5.5% range," said Vivek Jain, head-investments, Policybazaar, an online market place for insurance.

Most of the popular plans are non-participating plans, which means policyholders don’t get any bonus or dividend of the profits, according to Jain.

In the current scenario, these plans may look attractive as they can offer 4.5-5.9% post-tax returns over the long term. The returns vary as part of the premium would go towards payment of life cover (mortality charges).

The older the investor, the higher will be the allocation to mortality charges and lower would be the return if calculated based on the premiums paid. Younger investors can get slightly higher returns. Let’s look at these plans in detail and whether you should invest in them.

Reason for popularity

Besides offering guaranteed returns, these plans are popular as they are tax-free. “The popularity is due to tax-free returns on maturity, tax deduction on buying the policy and they are offering better returns than FDs. Many customers, who would typically invest in tax-free bonds, prefer guaranteed return products," said Dheeraj Sehgal, chief distribution officer, institutional, Bajaj Allianz Life Insurance Co. Ltd.

For investors, it can sometimes get difficult to understand and calculate the real return these plans offer. The communication from insurance companies talks about the amount of money (premiums) that customer needs to pay every year and what they will get when the policy matures.

A typical guaranteed return plan has different aspects that policyholders must consider before determining the actual returns post all charges or internal rate of return (IRR). In such plans, there is a premium paying term and a policy term.

The policy term is usually longer than the premium paying term. Say, the customer chooses to pay premiums for 10 years and the policy matures in 20 years, it means the insurer will pay out after 20 years. After 10 years of paying premiums, the policyholder must let the money grow for the remaining term.

To determine the returns, consider the mortality charge, amount invested and the tenure of the policy. Don’t just look at how much you invested and what the insurer is paying back.

With some insurers, the customer can also choose a staggered payout option. In this, the customer can get a payout every year for a specific term. “We have different products, and depending on the payout the customer needs, they can choose products," said Anjali Malhotra, chief customer, marketing, digital and IT officer at Aviva India.

Here are IRRs for two popular products sold on Policybazaar.com. In this example a 30-year-old man pays a premium of 60,000 and the insurer pays a lump sum on maturity. For HDFC Life Insurance’s Sanchay policy, the IRR will be 5.61% for a premium term of 10 years and a policy term of 15 years. In Aditya Birla Sun Life’s Guaranteed Milestone Plan, the IRR would be 5.51% for a premium paying term of 10 years and a policy term of 20 years.

Lack of liquidity

One of the drawbacks of a guaranteed return product is liquidity. “If a person wants to surrender the product, the money he will get back will eat into the gains made," said Suresh Sadagopan, founder, Ladder 7 Financial Advisories, a Sebi-registered investment advisory firm. The surrender value depends on factors such as premiums paid, guaranteed additions, sum assured and the policy term.

According to Sehgal, a customer should be sure that he can keep up to the commitment of paying premiums before buying the policy. “But if he needs urgent funds, there is also the option to take a loan against the policy," he added.

The loan may help you tide the financial problem and ensure continuity of a life cover, but it may lower the return on the policy, as it will come with an interest cost.

Sadagoapan suggested that investors who are fine with locking the money for the entire policy term should look at these products. “Guaranteed return product from life insurers makes sense for someone with a large portfolio, who has invested in other liquid products and is fine with locking away some portion of the portfolio for the long term," he said.

Should you opt for it?

If you are only opting for these products as they offer better returns than FDs or for the tax benefit, there are better alternatives that you can look at, for example, Employees’ Provident Fund, voluntary provident fund, public provident fund and National Pension Scheme (NPS).

These products come with a longer lock-in period, have tax benefits, and offer higher returns. Except for NPS, the other three products follow the EEE tax regime, that is, they offer tax benefits on investment and on accrual, while withdrawals are tax-free. NPS is market-linked and requires the subscriber to buy an annuity with a part of the corpus and the payout from the annuity is taxable.

Many agents sell this product telling investors that the interest rates in the economy have been coming down. It’s possible that the country could see rates below 5% in the future like it happens in the developed economies. But this is not entirely correct.

“It is also possible that in the future interest rates can rise and investors may feel that the returns from the guaranteed products are not optimal compared to FDs," said Deepesh Raghaw, a Sebi-registered investment adviser and founder of PersonalFinancePlan.

Before buying the guarantee return policy, calculate the actual returns (IRR) and ensure that you have provided for liquidity through other means for your future needs.

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