Wondering if an investment-linked insurance product is a good option for an investor? Find out!
The argument against hybrid insurance products is that they fail in both, generating better returns and offering adequate insurance cover. Another argument against these plans is that they are very expensive. The only thing that works in favour of investment-linked insurance products is convenience. They offer three benefits: insurance, investment and tax-saving. The last being the most important factor for the popularity of savings-cum-insurance products.
Types of investment-linked insurance products:
In a hybrid insurance plan, a part of the premium is used for offering life cover, and the remaining amount is invested in a portfolio of equity, debt or both, depending on the product you buy.
The two popular insurance products with investment components are—traditional endowment plans and Unit-Linked Insurance Plans (ULIPs).
Traditional endowment plans typically offer life cover that is 10-20 times the annual premium. If the annual premium is Rs. 50,000, the total life cover will be Rs. 5 lakh to Rs. 10 lakh. The investment portfolio largely comprises debt instruments. As a result, returns from these products are very low, sometimes as low as 5-6% annually. Besides, the cost structure and portfolio composition lack transparency. Investors do not know exactly where their money is being invested, and what charges they pay.
Compared to traditional endowment plans, ULIPs are more transparent products in terms of how the money is being invested and what charges are being deducted. Since investment portfolio can have up to 100% exposure in equities, over the long-term, ULIPs help investors build a decent corpus.
However, in terms of providing insurance cover, they are not very different from traditional plans. Most ULIPs do not offer life cover more than 25 times the annual premium.
For example, if the annual premium is Rs. 50,000, one cannot expect a life cover of more than Rs. 12.5 lakh. However, a pure protection plan (a term plan) offers Rs. 1 crore life cover for as low as Rs. 10,000-12,000 a year.
Tax benefits:
While investment in Life Insurance schemes is eligible for tax deduction, both, the death benefit and maturity benefit of an insurance policy are tax-free except in case of annuity plans, where the annuity payouts are taxable.
As the premium for insurance-linked investment plans is much higher compared to a pure term plan, it is easier to exhaust the deduction limit of Rs 1.5 lakh with a hybrid insurance product than a pure protection plan.
Irrespective of whether the Insurance policy invests in a debt-heavy or equity-heavy portfolio, the maturity benefit is always tax-free unlike Mutual Funds, where capital gains from debt funds are taxable.
A mix of term plan and mutual fund
Despite all the so-called ‘benefits’ of investment-linked insurance plans, investment planners generally prefer a combination of a term plan and mutual funds in the long-term. Both are simple and low-cost products, and as for tax benefits, tax-savings mutual funds offer income tax deduction as well as tax-free returns.
Read this to know more about Tax Implications on Life Insurance
Mutual funds also offer a variety of options and flexibility in terms of portfolio and time redemption.
Mutual funds being low-cost products help building bigger corpus over a given period than ULIPs, which are necessarily insurance-linked mutual funds.
However, ULIPs have a variety of charges especially in the first five years of the tenure. These include allocation charge, policy admin charge, mortality charge and fund management charge. The allocation charge in the first five years is approximately 4-6% annually, policy admin charges can be up to 2% and fund management charges can vary from 1-1.35% annually.
Mortality charges vary for different age groups. For a 30-year old healthy male, the mortality charge is around Rs. 1.5 for every Rs 1,000 life cover. For a cover of Rs. 1 crore the annual mortality charge is Rs. 15,000 a year.
These charges account for 12-15% of the premium and the rest is invested in a portfolio of equity, debt or both. On the other hand, mutual funds charge 3-3.5% (including service charge) a year.
Conclusion:
While savings-cum-insurance products (especially ULIPs) help in generating decent returns over the long-term, they lack severely in terms of offering adequate life cover.
The better way, therefore, is to have a pure term plan that takes care of all your insurance needs and invest in mutual funds for long-term wealth creation.
Additional Reading: 5 No-brainers before you take insurance