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Consider this: In 2014, fixed deposits (FDs) by banks were offering 8-8.5% returns, but now they are giving 5-5.5% returns. This has made finding an investment instrument offering both safe and decent returns an uphill task.

Amid the uncertainties and the low-interest rate regime, many investors have been moving towards life insurance policies offering pure protection and guaranteed returns, claim insurance industry executives.

“There is a definite shift in consumer preference towards guaranteed insurance plans since they offer capital protection and stable returns. Besides, it enables customers to eliminate the uncertainty of future income streams to a large extent, and the life cover provides financial security to the family, which is essential in the current times," said Amit Palta, chief of distribution, ICICI Prudential Life Insurance Co. Ltd.

Photo from istockphoto; graphic: Paras Jain/Mint
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Photo from istockphoto; graphic: Paras Jain/Mint


For example, SBI’s five-year FD is giving 5.40% interest, while HDFC Life’s Sanchay Plus-Long Term Income is offering a 6.04% payout. Moreover, the absolute returns from a bank FD may fall after tax deduction as per your slab rate.

However, there are a number of pitfalls in such insurance policies. Let’s look at these plans in detail and whether you should invest in them.

WHAT INVESTORS GET

During the sales pitch, it is mentioned that these are guaranteed plans and are not linked to market returns. This makes such plans much more compelling from the selling perspective.

Short-term interest rates have fallen over the past five years. However, long-term rates on instruments such as government bond yields haven’t gone down in a big manner.

“That’s why guaranteed return plans offered by insurance companies, where the underlying instruments are government bonds, have been able to give better returns than FDs," said Vivek Jain, head of investments, Policybazaar, an online marketplace for insurance.

Moreover, since these plans are tax-free, investors get a tax benefit under Section 80C and even the returns are tax-free under Section 10(10)D provided the insurance cover is at least 10 times the annual premium.

“So, for investors in the 20% and 30% tax brackets, FDs are giving post-tax 4-4.5% returns, while these plans are giving 5-6% post-tax returns," added Jain.

A major catch in the value proposition is the policy term, which acts as a lock-in period. The minimum policy term is five years, but such policies also tend to have longer terms. Missing a premium payment can cause the policy to lapse, costing you all or some of the money you have already paid as premium, although a revival period of up to two years is generally offered.

WHAT EXPERTS SAY

Financial advisers say that mixing life insurance and investment is not a smart way to manage risk and money.

“Insurance is a distinct subject compared to investment and when you look at life insurance, the first thing you should look at is term insurance rather than unit-linked insurance or endowment plans," said Abhishek Bondia, MD and principal officer, SecureNow.in, an insurance broker.

Moreover, as some part of the money in these plans gets allocated to term insurance, the returns get capped.

As things stand, 5-6% returns might look attractive today, but that might not be the case in the future. Experts feel that sooner than later, interest rates are bound to increase.

“As these are guaranteed plans, a big portion of the money needs to be invested in debt instruments, and the rates are going to be locked in at current rates, which have been low over the past few years," said Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Sebi-registered investment adviser.

One big drawback of a guaranteed return product is liquidity because the money an investor will get back will eat into the gains made if he or she wants to surrender the product.

For whom does it work?

However, according to Sadagopan, investors who have a very low-risk appetite, a long-term horizon, don’t want any volatility and want to know upfront the potential returns can invest in these plans.

From a tax perspective, ultra-high-net-worth individuals (HNIs) may find these plans lucrative.

“If an HNI investor is looking for a 6% tax-free interest from guaranteed insurance plans, he or she has to look for instruments with a 8-8.5% payout for the kind of tax payment to reach 6% post-tax. So, there can be a merit for these plans for ultra HNI clients, given the interest rate scenario," said Kirtan Shah, chief financial planner at Sykes and Ray Equities (I) Ltd.

Shah added that insurance as an investment is not something that people should look at, as investors won’t get anything higher than 5-6%. Moreover, if an investor locks in his/her money for a longer tenure, they might miss out on the increased rates that might happen in the future.

Better options

If you are only opting for these products due to better returns or tax benefit, there are better alternatives.

For retail investors with a low-risk profile, there are options such as National Savings Certificate (NSC), Post Office Monthly Income Scheme and RBI floating rate bonds. While the NSC is currently offering 6.8% returns, post office schemes have a payout in the range of 4% to 6.7%, while RBI bonds offer 7.15% interest.

For a 35-year-old retail investor, the objective of debt investment should be strategic and not income generation. A moderately risky investor should allocate 60% in equity and the rest in fixed income investment. However, investors should not go for locking in their investment in the debt portion for the long term.

An investment strategy for people in this age group could be bonds or highly rated non-convertible debentures or debt mutual funds.

“Potentially, you can get better returns from these instruments, and you don’t have to lock in investments for a long period. As and when interest rates rise, there may be more opportunities," said Sadagopan.

For senior citizens who are looking for a stable income, have low-risk appetite and need to protect their capital, the Senior Citizens Savings Scheme and Pradhan Mantri Vaya Vandana Yojana are better bets as they both offer 7.4% returns.

The mantra for getting maximum returns in a guaranteed product is to invest at an early age and stay invested for the long term, but look at the liquidity factor, risk profile and interest rate returns while investing.

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