"Boond boond se sagar banata hai" If one goes by this saying, small but periodic investments can grow to a large sum at maturity. This is the basic investment logic behind recurring deposit schemes. Banks and post offices have been offering such schemes in India. LIC, the largest life insurance company in the country, has now joined this club. LIC launched a special plan called Jeevan Saral a couple of years back to cater to such investor needs.
Jeevan Saral is nothing but an endowment assurance plan where the policyholder simply has to choose the amount and mode of premium payment. The plan provides protection against death throughout the plan term to the extent of 250 times of the monthly premium. For example, anyone opting to pay a monthly premium of Rs 1000 will get a risk cover of Rs 2,50,000 during the policy period.
The policy term varies according to the age of the policyholder. The death benefit includes the total risk cover and loyalty bonus, if any. LIC also promises return of premiums, excluding first-year premiums and extra/rider premiums.
This scheme also offers an accidental death benefit. In real life, it's rare for a policyholder to die during the term of the policy. Even LIC accepts that over 95% of its policyholders survive the policy period and for most policyholders, insurance becomes just another investment. However, unlike pure investment, in case of insurance policies, one would have to wait till end of the policy term to get back the amount assured. This may be as long as 20-25 years. Early policy surrender involves costs in terms of penalty. But this does not hold true for Jeevan Saral.
The policy offers high liquidity to the policyholder. After five years of active policy (premium paid without default), which corresponds to the term for which premiums have been paid under the policy, one may receive 100% of the Maturity Sum Assured (MSA). (These MSA values are given by LIC). However, one can withdraw partial or full MSA amount after the 10th year.
Moreover, this is a with-profits plan. Loyalty additions (i.e. bonus) are payable from the 10th year, along with guaranteed maturity benefits. Loyalty addition is nothing but terminal bonus, which actually depends on the profits of LIC's life insurance business. Thus, it is variable return that cannot be estimated at the beginning of the policy.
Jeevan Saral as an investment option needs to be compared with other avenues such as recurring deposit (RD) offered by banks and post offices or periodical investments in Public provident Fund (PPF). Recurring deposits enjoy liquidity but no tax benefits, while PPF carries tax benefit minus liquidity. Since Jeevan Saral offers both the benefits, it is necessary to compare its returns with other schemes.
Suppose 30-year old Mr A opts for a policy involving monthly premium payment of Rs 1000 for 20 years. The total premium paid will be Rs 2,40,000 at the end of the 20th year, which assures maturity sum of Rs 2,73,500 and loyalty addition at the rate announced for the corresponding year. (The average rate at which the bonuses were offered for the past five years was around 5-6%). So if we assume that 6% loyalty will be paid in the 20th year, the total lump-sum earnings at maturity will be around Rs 3,48,000. Thus, the net earnings will be around Rs 1,00,000 in 20 years.
Instead, Mr B opens a recurring deposit with a PSU bank for 20 years. (The maximum RD period offered is 10 years, but we have assumed RD of 20 years to make it comparable). The deposit rate offered by most banks for 10 years is 7% per annum compounded quarterly.
So, the amount receivable after 20 years will be around Rs 5,21,000. Thus, the interest earnings will be Rs 2,81,000, much higher than the guaranteed returns on Jeevan Saral. But one should not forget that the interest income on RD is taxable. Assuming Mr B is in the highest income tax bracket, the total tax paid will be Rs 87,000 and the net interest earned after tax adjustment will be Rs 1,94,000, which is still higher than the returns offered by Jeevan Saral. But not all investors need to pay the highest applicable rate of income tax as RDs don't attract TDS.
Now consider Mr C, who opts to make monthly investment of Rs 1000 in PPF account for 20 years. He enjoys tax benefit under sec 80c similar to Mr A. At the end of 20th year, he receives almost Rs 5,93,000. Thus, the net earnings for Mr C will be Rs 3,53,000, which will be absolutely tax-free. Moreover, these assured earnings may be much higher than the receivables of Mr A.
To sum up, if one is looking for a pure long-term investment with periodical payout, traditional fixed investment avenues such as RDs and PPFs score for insurance based investment plans. As for risk cover, one may go for pure-term policies which have very low premiums.
Source: economic times
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December 22, 2011