Term Life Insurance or Endowment Insurance – which is better?
Even before we start comparing Term Life Insurance with Endowment, let me first explain to you how insurance is perceived in our country and in the process, I intend to bust one of the greatest myths of personal finance that is “Insurance is an Investment.” People often confuse insurance as an investment, and an increasing number of people are “investing” in insurance. Of course, they are undeniably being driven by the ambush marketing of insurance companies that spends huge money on branding. These companies prefer to label their products as investments.
The situation today is starkly different from yesteryears when insurance was truly a matter of solicitation by agents. Insurance advertising in media, which was scant even a decade back, has increased by leaps and bounds. Well, there is nothing wrong with that because it’s a product after all, which needs to be sold. What is wrong is that the bulk of the money flowing into an insurance company’s coffers is essentially towards investment and not as payment for insurance.
The aim of insurance
Let’s first check out the purpose of insurance and what it serves. All insurance plans aim to protect you from financial risks.
“While life insurance helps you to secure the future of your loved ones financially after your death, car insurance ensures that accidents don’t leave you bankrupt, health insurance on its part, ensures that medical bills don’t dig a hole in your pocket.”
What this means is, Insurance is a premium that you pay to cover any unforeseen risks, which also implies that insurance in its purest form is an expense rather than an investment. Insurance, in India, is widely viewed as a tax-saving instrument. Most people put away an amount of money every year to “invest” in insurance—more specifically—life insurance. Of course, there are products like endowment plans, Money-back plans etc. which are insurance products camouflaged as investment products, not to forget ULIPs which were known for their charges than returns. Things get a bit murkier when insurance is considered more as an investment than as insurance, as it will neither serve your objective of investment nor insurance.
How much insurance do I need?
Buying insurance is important. But a far more important question is how much insurance is adequate? What’s the approximate amount that will ensure that your family’s future is secure?
In India, when it comes to buying a life insurance policy, we mostly hear of calculating insurance requirement by using the Human Life Value (HLV) system. But HLV considers the income of the person and takes multiple assumptions that aren’t tenable over the long run. Below are some points to consider to arrive at a more realistic result:
Liabilities: Consider all your debts. These include all your personal loans, home loans, vehicle loan, outstanding balance on your credit card, mortgage payoff, etc.
Income replacement: The purpose of life insurance is to ensure that your family continues with the same lifestyle after you. Calculate the money your family will need for sustenance. Include all items like education fees, grocery, and other household expenses.
Gross annual earnings: The thumb rule for required insurance calculation is to take your gross annual earnings and multiply it by 12. Then add all the outstanding loans and subtract all liquid assets and savings that you have. The resultant figure would be the amount of insurance that you need.
What is a term life insurance?
Term insurance plans are a type of life cover(In fact, term insurance is the purest form of insurance). They give coverage for a fixed period of time. If the insured dies during the policy term, then the death benefits are paid to the nominee. The plans are particularly designed for securing the needs of your family.
The premium for term insurance policies is the lowest among all the insurance products because there’s no investment component and the full premium is used to cover the risk. There’s no maturity or survival benefit once the policy term ends. There could be some plans, offering a return of premiums paid, if the insured person, survives.
What is an endowment insurance?
An endowment insurance plan is a combination of a savings plan and a protection plan. These policies cover risks for a particular period. The premium of endowment policies is much higher compared to that of term insurance plans. In case of the death of the insured, before completion of the policy term, the sum assured and accumulated bonuses are paid to the nominee. Survival benefits in endowment policies are paid to the insured if he/she survives the term, along with the accumulated bonuses as declared by the insurance company.
Endowment policies are meant for those looking for regular savings with a 100% guarantee on their investment, those who require a lesser sum assured, and a lump sum amount at a particular age. The following points must be considered before taking a policy:
1. Bonuses are not assured. They are usually paid when the insurance company rakes in profits.
2. If you want to surrender the policy within three years of subscribing it, you might receive a meagre/nil surrender value.
3. If you retain the policy for the entire term, the yield usually varies 3% to 6% depending upon your policy.
When should you “invest” in insurance? i.e., buy a non-term insurance product
If you don’t trust yourself to take wise investment decisions and frequently change your mind as well as investment plans, then an insurance plan may be a worthy savings option. An insurance plan—by its very nature—forces you to save over decades on end. It works for those who lack financial discipline. But it only works if you can continue payments over the entire duration. Discontinuing the plan midway will be a bad call, especially if you have been using it as an investment, whether knowingly or unknowingly.
If you are comfortable with the kind of returns that these products give which could be around 3 to 6% per annum, depending upon the product you have chosen.
If you are risk averse and, capital protection is your top priority. And, If you have exhausted all other saving options like PPF/VPF/Sukanya Samruddhi account etc.
Mashing up investment with insurance is unwise. And term insurance policies are much better because there’s no investment angle, and thus, no returns on maturity. A term plan charges the premium only for protection and not for investment while the endowment plan charges both for investment and protection.
Endowment plans on the other hand, charges more premium than term insurance for an identical coverage and duration because they will invest the money in various instruments after deducting the insurance amount, mortality, and other charges. It returns a part of the income to the policyholder on maturity.
Also read: Types of Life Insurance Policies in India
Term life insurance beats endowment insurance hands down
Remember, endowment plans are not proper for protection purposes, which is the primary objective of taking an insurance policy. Endowment policies can be bought by only those who want a little protection and full guarantee of their investment. But if you want to get protected from unexpected contingencies, then subscribe to a pure term insurance plan. It comes at a low cost. Remember, insurance is not meant for investment but protection. A better alternative to an endowment plan would be to go for a Term plan + VPF/Debt Instrument/Equity mutual fund, based on your risk profile.
Just keep in mind that insurance plays a specific role in your financial safety net. Insurance products are there if you need them. You never plan to use it but for an eventuality.
“Term insurance is a waste of money”; you might have heard this from many agents, advocating you not to buy a term plan. Hope now you will be in a better position to counter them. As you now understand that insurance is an expense and for investing you have better options.